Yen downside amp Nikkei 8217 s rally

Japan has long spoken about the need to address the nation’s aging population and offer better returns to meet growing pension payouts. It is finally addressing the problem, and the yen is falling accordingly.

Earlier this month, Japanese PM Shinzo Abe named Yasuhisa Shiozaki as new health minister to overhaul the nation’s $1.2 trillion Government Pension Investment Fund. The Fund is expected to cut its local bond target to 40% from the current 60%, and raise Japanese shares exposure to 20% from 12%. This would require the GPIF to buy yen 3.5 tn in local stocks to reach the 20% level.

A bill to overhaul GPIF’s governance structure is expected to be submitted in the next parliamentary session.

As reforms of the GPIF get underway, other funds could follow suit. The governor of Tokyo is said to be considering more aggressive investments of the city’s yen 3.4 tn fund ($32bn), deploying them into higher-yielding securities such as equities, property and other high-returning domestic and foreign assets.

According to the Financial Times, there are at least three other funds considering a similar overhaul; the Federation of National Public Service Personnel Mutual Aid Associations, the Pension Fund Association for Local Government Officials, and the Promotion and Mutual Aid Corporation for Private Schools of Japan, with allocations to domestic equities, ranging from 5 to 14% of assets.

Japanese officials are referring to California Public Employees’ Retirement System as amodel for the GPIF. The $300bn Calpers placed 50% of its assets in global equities.

Yen & Nikkei implications

The currency implications of a rebalancing in the GPIF’s equity portfolio would be enormous. The 7% yen decline against the US dollar of the past 2 months could be just the beginning. A reduction in JGBs allocation may boost yields, especially if the current bounce in global bond yields is maintained. Such a move would likely occur if Japan’s inflation remains on an upward path towards the new 2.0% target.

The possibility of seeing a 109 print in USDJPY is increasingly plausible as Japanese investors’ search for yields is satisfied abroad. The Federal Reserve’s baby steps towards monetary policy normalisation following next month’s planned ending of QE3 should boost the USD-part of USDJPY as long as US data maintains recent showing in labour markets. Further yen weakness would also mean a further run-up in the Nikkei-225. A 7.5% rise in the Nikkei to 17,000 from current levels could well be on the way as long as Tokyo’s efforts to reflate the economy are proven successful. The major impediment to such a rally will be the fate of consumer spending, which are already dampened by the April tax hike from 5% to 8%. Credit rating agencies are pressuring Tokyo to stick with plans to levy another tax hike for October of next year. As long as none of these developments interrupt risk appetite in local and global equities, the road to 109 yen and 17,000 Nikkei may well happen by year-end.