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MENAFN - Arab News - 31/01/2013

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(MENAFN - Arab News) The Japanese yen should stay weak even if the price action in the dollar/yen exchange rate is confined in the coming days by market talk of very large option maturities in the 90-91.50 yen area.

IFR, a Thomson Reuters service, sees substantial option expiries on Jan. 31 which could constrain spot market activity. Some 3 billion of 90.00s are said to be rolling off, along with 2.5 billion of 91.50s and large maturities also at 90.50 and 91.00.

Such a volume of expiries could generate sufficient activity in the spot market temporarily to curb dollar/yen but, beyond that short term market noise, the argument for continuing yen weakness remains solid.

Tuesday's Japanese budget, reflecting Japan's rapidly aging population, saw social security spending reach 29.1 trillion yen, accounting for one-third of spending.

An aging and therefore less-likely-to-be-working population lives off its savings and pensions, and this trend can be discerned in Japan's GPIF, the world's largest public pension fund.

GPIF, whose portfolio is equivalent in size to the economy of Australia, has been paying out more in benefits than it receives in contributions to the national pension system since the 2009/10 financial year.

That can be partially seen in the deterioration in Japan's current account which swung to a much larger than expected deficit in November.

Setting aside Japan's present trade deficit, as the aging population draws down on its savings, the stock of overseas assets, which has provided income to support an overall current account surplus over the years, is eroded.

That in turn arguably makes Japan's overall economic position more precarious given its very large debt-to-gross-domestic-product ratio and so may lead investors to shun the yen.

Yet, at the same time, Japan's pension and mutual funds still need to manage the shrinking pot of Japanese savings to achieve the best returns, and that may encourage even more capital outflows from the yen into overseas assets.

GPIF invests reserves of national and employees' pension plans and allocates nearly two-thirds of its assets to Japanese government bonds (JGBs) but in the July-September period, achieved its biggest investment gain from foreign stocks.

This occurred before the deep slide in the value of the yen against the dollar from 77.41 on Sep. 28 to 91.25 on Monday which would have further augmented the value of dollar assets in yen-denominated terms.

That can generate further yen-negative investor behavior as market psychology shifts.

Japanese investors who accept the idea of further yen weakness will move more assets offshore, looking to gain from the yen's slide.

Japan's largest mutual fund, Kokusai Asset's Global Sovereign Open 17.5 billion bond fund, bought European Financial Stability Facility (EFSF) bonds for the first time in two years, the manager of the fund said recently.

While that has been portrayed as rising confidence in the euro zone, the flip side may be that it is also an attempt to reduce, at the margin, exposure to Japan.

There is also the question of how holders of JGBs react to the Bank of Japan's new mandate to target 2 percent inflation given that Japan is still fighting deflation.

Japan's core consumer prices fell 0.2 percent in December from a year earlier, government data showed on Friday, showing just how big a challenge faces the BOJ.

Investors, noting the BOJ's new inflation target, and who also accept the idea of further yen weakness, could opt to trim JGB holdings and head offshore.

After all, if the scenario plays out, Japanese yields might rise, lowering the price of the bond and adversely affecting the capital value of JGB portfolios.

The arguments for continuing yen weakness remain intact.

Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own.


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