March 28, 2017 5:00 am JST

Speculators smell stronger yen ahead

ETFs betting against currency lose out as reflation trade sputters

KEIDAI SANDA, Nikkei staff writer

TOKYO -- Speculators are pulling away from exchange-traded funds that profit from a weak yen, seeing strength ahead for the Japanese currency as doubts emerge over U.S. policy.

ProShares UltraShort Yen, a U.S. ETF betting against Japan's currency, is seen as a weathervane for the sentiment of hedge funds and other short-term investors. Net assets have shrunk to $224 million, the lowest since last July, when the yen traded at around 105 against the greenback.

The fund's assets stayed under $200 million during the first half of last year, but climbed to $300 million at one point as the yen sold off following Donald Trump's election as U.S. president in November. But outflows are quickening as speculators reckon on a yen rebound. "The trend toward a weaker yen and higher stock prices that we had been seeing since the end of last year is gone now," said a Japanese hedge fund manager.

Fading excitement over the outlook for U.S. monetary and fiscal policies is a major factor in this change. From last autumn, expectations that the Federal Reserve would speed its pace of interest rate hikes drove dollar buying, and yen selling rose on hopes that expansionary fiscal policy from the Trump administration would make investors hungrier for risk.

But Fed policymakers indicated in their March meeting that they expect to raise interest rates just three times this year. Since then, Fed voices have made statements ranging from the dovish to the hawkish. On the government side, House Republicans on Friday withdrew a major bill to overhaul the nation's health care, casting doubt over their ability to achieve other goals, including tax reforms and infrastructure spending.

The yen traded at the low end of the 110 handle against the dollar in the Tokyo market Monday. There was "no reason" in sight to buy the dollar, said Akira Moroga of Aozora Bank.

The options market showed similar caution. The one-month risk reversal for yen/dollar, which shrinks as expectations grow for a stronger yen, has fallen back to around minus 1.5%, the lowest since early November.

Supply-demand factors that help weaken the yen are also diminishing. Japanese financial institutions got burned on foreign-bond investments as U.S. interest rates rose early in the Trump rally, discouraging regional banks and others from trying again. With Japan's Financial Services Agency also beginning to inspect regional banks' asset management, demand has cooled for the yen-dollar transactions that accompany such foreign-debt investment.

Basis swaps, a factor in Japanese banks' dollar funding costs, are falling. As the cost of maintaining hedges on their foreign-debt holdings declines, there will be a greater tendency to put off unwinding hedges, said Osamu Takashima at Citigroup Global Markets Japan. This contributes to market conditions that favor yen buying.

In April, the U.S. and Japan are set to begin a new economic dialogue, and the Treasury will release its next closely watched report on foreign exchange. Depending on events play out, safe-haven yen buying could accelerate. The case for a stronger yen looks likely to remain strong for a while.

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