A Bloomberg story tells us that Japanese retail investors are undermining the forecasts (and worse, trades) of large investment banks. The banks think the yen is seriously undervalued. Unfortunately, when it appreciates, retail investors buy more assets in countries that offer more yield, which leads them to sell yen, keeping the currency in its place.
To the extent that Japanese investor are playing with their own savings, this pattern isn’t necessarily a bad thing. However, the Bloomberg story makes it sound as if this investing taking the shape of a bubble. Retail investors are taking on leverage to make these investments, are engaging a lot of short-term trading, and appear to be having a bit too much fun (meaning the considerable risks are being overlooked). Dot come redux?
Japanese businessmen, housewives and pensioners betting against the yen in their spare time are wrecking the forecasts of the world’s biggest currency traders.
The yen has slumped 4.6 percent to a 4 1/2-year low against the dollar this quarter, making it the worst performer among 72 major currencies and confounding predictions by strategists at Deutsche Bank AG and UBS AG for gains of about 1 percent.
The banks didn’t reckon on the risk appetite of Japanese individuals, who are borrowing money like never before to buy currencies with higher yields. They tripled their trading in the year ended March to a record $11 billion a day, according to Tokyo-based Yano Research Institute Ltd., publisher of an annual report on the business. Globally, currency trading by retail investors rose 54 percent in 2006, according to research firm Greenwich Associates in Greenwich, Connecticut.
“Japan’s interest rates are too low,” said Hiroshi Ono, a 40-year-old sales clerk at a telephone company in Tokyo. Ono said he has made about $17,000 since March by borrowing $200,000 of yen and buying U.S. dollars to take advantage of the 4.75 percentage-point difference between Japanese and U.S. interest rates.
Japanese investors are borrowing yen at the central bank’s 0.5 percent overnight lending rate and buying higher-yielding currencies in New Zealand, the U.K., Australia and even Brazil to increase returns on 1,536 trillion yen ($12.5 trillion) in savings. The strategy is called the carry trade.
Japan’s overnight rate, the lowest among major economies, is 7.5 percentage points less than New Zealand’s key rate and 3.5 percentage points below that of the European Central Bank.
“Japan’s margin traders have the power to support currencies against the yen,” said Derek Halpenny, a strategist in London at Bank of Tokyo-Mitsubishi UFJ Ltd., a unit of Japan’s biggest lender. “We estimate they make up 15 percent of yen trading in Tokyo hours. Maybe even more.”
The yen slumped 1.4 percent last week to 123.44 per dollar and dropped 1.5 percent to 165.26 to the euro. The currency fell to a record low of 165.60 per euro today. Halpenny predicts the yen will reach 125 per dollar before ending Sept. 30 at 123.
“The yen carry trade is still alive,” said Koji Fukaya, senior currency strategist in Tokyo at Deutsche Securities, a Deutsche Bank subsidiary. “Capital outflows from Japan remain steady and more than we expected.”
Unwinding Carry Trades
The Frankfurt-based bank, the biggest currency trader according to Euromoney magazine, forecast at the end of March that the yen would trade at 117 per dollar by June 30, matching the median of 39 analysts, traders and investors in a Bloomberg News survey. Zurich-based UBS, ranked second, predicted 116.
In late December, Deutsche Bank forecast the yen would rise to 113 yen by the end of the first quarter and UBS predicted 111. It fell to 117.83.
UBS and Deutsche Bank are sticking to their forecasts for a stronger yen, saying central bank curbs on money supply will starve the carry trade.
“Tighter global liquidity will contribute to increased volatility and enable the yen to strengthen as the carry trade is unwound,” said Ashley Davies, currency strategist in Singapore at UBS, which expects the yen to gain to 121 per dollar in a month and to 117 in three months.
Bane of Pros
Retail investors’ strategy of selling yen during rallies helped push volatility implied by one-month dollar-yen options on June 5 to 5.85 percent, the lowest since the Bank of Japan began compiling data in August 1992, compared with 10.15 percent on March 5. Lower volatility may encourage carry trades, as it implies smaller exchange-rate fluctuation risk.
“They are the bane of professional currency traders,” said Masanobu Ishikawa, general manager of foreign exchange at Tokyo Forex & Ueda Harlow Ltd., who has been trading in Japan’s capital city for 25 years. “It’s becoming hard to make money as the dollar-yen doesn’t move as it used to, because of their constant buying on dips.”
Global trading by investors other than banks, fund managers and companies surged 54 percent last year, said Peter D’Amario, a consultant at Greenwich Associates. The category, which includes retail investors, accounted for 16 percent of trades handled by 1,700 firms surveyed, up from 10 percent a year earlier. It grew 80 percent in Europe, 55 percent in Asia Pacific and 30 percent in the Americas.
In Japan, individuals have opened 600,000 so-called margin trading accounts at brokerages that lend money for currency bets, 80 percent more than a year ago, according to Yano Research.
Buying on Dips
When the yen rose to a two-week high of 162.20 against the euro on May 25, Naoko Ogawa, a 34-year-old freelance writer, used a 1,000 euro ($1,300) deposit to buy 10,000 euros. She sold four days later, close to a then-record high of 164.29 yen.
“You just need to buy the dollar and the euro on dips, then sell them at a profit,” said Ogawa, who added that she has made a 20 percent return on her 1 million yen trading account since December. “It’s better than stock trading, as you can rely on daily interest.”
Deposits in margin trading brokerages have risen 60 percent to $4.9 billion in the past year, Yano Research found. While that’s about 2 percent of the $272 billion that Japanese individuals have put into mutual funds that invest overseas, borrowing typically makes their positions 10 to 30 times larger.
Japanese traders stepped up their purchases of the New Zealand dollar when the Reserve Bank of New Zealand sold its currency on June 11, weakening the so-called kiwi by as much as 1.8 percent.
Margin traders’ net long positions in the New Zealand dollar against the yen doubled to $347 million on that day from $180 million on June 8, according to data from Tokyo Financial Exchange. Long positions are bets that a currency will rise. A carry trade that bought the New Zealand dollar funded with yen would have returned 14 percent this year.
The nation’s dollar fell this morning on speculation the Reserve Bank sold its currency for a second time, only to rebound in the afternoon to a 19-year high against the yen.
Deutsche Bank officials began weekly visits with 30 Japanese margin trading brokerages after the orders they channel through the firm doubled in a year, said Drew Bradford, head of global finance and foreign exchange in Tokyo, where the lender’s currency sales team has tripled to 17 in a year.
“The growth is phenomenal,” he said. “They are buying pounds, Australian and New Zealand dollars. The more adventurous are looking at the Brazilian real and Turkish lira.”
In an April report, the Bank of Japan highlighted the risk that investors may make imprudent decisions based on “favorable” assumptions about foreign-exchange and interest rates.
Governor Toshihiko Fukui followed that with another warning, saying expectations that rates will stay low could invite “inefficient” investment. “If stock and bond markets or the yen carry trade become unbalanced and unwind, that would have a negative effect on the economy,” he told lawmakers on June 5.
When the carry trade collapsed in 1998 following Russia’s debt default, the yen jumped 20 percent in less than two months. The biggest challenge to the strategy this year came when Chinese stocks slumped on Feb. 27, prompting fund managers to cut riskier investments and pay back yen loans. The yen rose 2.3 percent in a single day, the biggest gain since July 2005.
Hire the Housewife
Japan’s recovery has actually helped to weaken the yen by increasing the appetite of local investors for risk, said Masafumi Yamamoto, currency economist at Nikko Citigroup Ltd. in Tokyo and a former Bank of Japan currency trader.
“It is likely Japanese retail investors will continue to increase their foreign currency exposure, especially to that of high-yielding currencies like the New Zealand dollar,” he said.
Yukiko Ikebe, a 59-year-old housewife in Tokyo, in April was indicted for evading about 139 million yen in income taxes while earning 407 million yen trading foreign-exchange, according to the Tokyo District Public Prosecutors Office.
“She must have earned more money than us,” joked Yuji Saito, head of the foreign-exchange sales department at Societe Generale SA in Tokyo. “I said to my colleagues, `let’s find her and hire her!”’