Has Japan finally taken the emergency hammer and broken the “strengthen-yen-here” glass?
Finance Minister Satsuki Katayama pulled a genuine surprise on Friday when she announced toward the end of a regularly scheduled press conference that the government would pursue policies to encourage its massive pension funds to invest more at home. Details were sparse, and the yen wasn’t mentioned directly.
But the fact that officials dropped this unexpectedly, in a country where everything from growth plans to the Bank of Japan’s rate hikes are carefully leaked to the press in advance, suggests Katayama wanted the element of surprise. And markets responded, with the yen strengthening in the direction of 161, and bonds rising.
Nonetheless, this is an idea that has been floating around the market for months — that the government could nudge the Government Pension Investment Fund, which manages ¥293.6 trillion ($1.81 trillion), along with other pension funds that follow its portfolio, to invest more domestically. My colleague Daniel Moss and I made the argument in favor of such action back in January.
It’s the smartest move to play for the yen. For over two years, we have been hearing how the BOJ must raise rates and close the gap with the US to strengthen the currency. Five increases later and with the target rate at the highest since 1995, the yen is weaker now than when rates were negative. This reality has been divorced from fundamentals for years; what’s needed is a change in the narrative (the same is true in South Korea, where much faster and higher borrowing costs have not worked to support the won.)
Meanwhile, interventions are only ever a short-term tool. The strategy over the Golden Week holidays in May that sought to take advantage of thin liquidity was a smart one but didn’t meaningfully shift the currency’s direction.
Nudging the GPIF would not just be good for the yen. A large, steady domestic buyer would also calm the volatile JGB market and tamp overblown fears about Japan’s fiscal position by anchoring demand.
More than that, instead of exporting its capital abroad, Japan should benefit more from the returns available at home, at a time when investment is needed.
The late Prime Minister Shinzo Abe’s push to have the GPIF invest abroad was the right policy for a deflationary country, when the 10-year domestic bond yielded just 0.5% and the Nikkei 225 languished around 15,000 yen. The changes moved money out of JGBs, which had made up two-thirds of its portfolio, and into foreign bonds, along with domestic and foreign shares. It paid off: Japan’s pension future looks vastly better thanks to its assiduous investment choices.
But things are very different now. The fund still holds roughly half of its money overseas, and can afford to bring some home without giving up diversification. After decades of near-zero rates, Japan lives in a “world with interest” and assets are now compelling enough that more of its cash should stay onshore, where savers risk missing out on the domestic recovery.
In equities, shareholder returns have soared, corporate governance has been reformed and the Nikkei is around 70,000. Japanese bond yields may be volatile, but ignore the “highest in 30 years” headlines. These are just bumps on the road of normalization, after the suppression of rates for almost three decades. JGB yields aren’t spectacular in absolute terms, and modest GPIF buying could nudge them lower. But the gap with Treasuries has narrowed enough that a fund paying yen benefits has little reason to keep reaching abroad for a shrinking premium while holding FX risk.
That less money would flow offshore, easing pressure on the yen, would be merely a side benefit. But the government must tread carefully. The dirty not-quite-secret is that this administration likes the currency quite weak, seeing 150 or so to the dollar as a sweet spot that encourages exactly the kind of domestic investment Prime Minister Sanae Takaichi is calling for. Officials will be wary about spooking markets too quickly in the other direction and throwing off capex plans.
It’s also unclear what Katayama has in mind. The GPIF falls under the supervision of the health ministry, and is not due for a portfolio rebalancing anytime soon. Any attempt to do so will likely be unhelpfully framed as government meddling in pensioners’ savings and require the kind of political capital and careful handling of the 2014 rebalancing, which was preceded by a months-long review process.
But directionally, it’s a play that makes sense for all parties. If Japan is going to build a post-deflation industrial state, its capital should participate in the returns.
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