How Japan’s Stock Market Affects US Rates
Since the beginning of May, the Japanese stock market has risen by over 16%,
and last night, posted its biggest one day gain in over 7 months. This
mini-rally has been fueled by investor belief that the protracted Japanese
economic contraction may be finally coming to an end. What has been most
notable about this occurrence, however, is that foreigners have been very
active buyers from the beginning of the move and are becoming increasingly more aggressive
with the size of their allocations. In fact, foreign purchases of Japanese
equities are now reaching their highest levels in years.
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Should US-focused investors care?
Yes. The Japanese economy is highly dependant on exports for its livelihood,
and this substantial pickup in investor flows to Japan is causing its
currency–the yen–to strengthen. However, a stronger currency also means
that Japanese exports are more expensive relative to goods produced in the
US. As a result, the Bank of Japan will intervenes in the currency markets (buying
US dollars while selling their country’s currency)if the yen currency were to strengthens too much, in an effort to keep its country’s goods competitively
priced. Typically, during periods of intervention, most of the US dollars that are purchased by the Bank of
Japan go towards purchasing low-risk US Treasuries. For example, during the month
of May, the Bank of Japan purchased a record breaking $34 billion worth of
Treasuries. This helped push Treasury yields lower, resulting in lower interest rates for businesses and consumers.
So keep an eye on the Nikkei and the yen for that matter–particularly as the Japanese currency approaches the 115-116 level, which is where the Bank of Japan is most likely to intervene and buy dollars/Treasuries.
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