Yen's safe-haven status waning despite its rally in global rout

By Lisa Twaronite and Hideyuki Sano

TOKYO (Reuters) - The yen's rise in reaction to turmoil in emerging markets may have suggested the currency is still viewed as a good defensive play, but closer analysis shows it is actually losing some of its safe-haven status.

The yen has fallen as the Bank of Japan has been printing money aggressively as part of Japan's economic stimulus measures. There is little safety in holding a depreciating currency, so it might seem odd that the yen still rose in the emerging market selloff and fell when emerging markets settled.

Closer inspection, however, suggests the yen is indeed losing some of its status as a sound defensive play and analysts say little new positioning was taken up in the yen over this past week in search of safety.

The yen spiked to seven-week highs against both the dollar and the euro, as investors reacted to a wave of anxiety about emerging markets. But the gains quickly unravelled because far from being driven by new money, it was mainly speculators covering their short positions - bets the yen would lose value.

"Long-term investors do not regard the yen as a safe haven. The truth is the yen is being bought back because of position unwinding," said Osamu Takashima, chief FX strategist at Citigroup Global Markets in Tokyo.

Speculators' net short positions in the yen have fallen back from their highs in recent weeks, although figures covering Monday's yen spike, during the emerging market selloff, have yet to be published.

Foreign exchange strategists polled by Reuters are also bearish, expecting the yen to slide to 104 per dollar in one month, to 106 in six months and to 110 in a year.

The yen hit a seven-week high of 101.77 against the dollar on Monday and its gains since last Thursday, when emerging market woes engulfed global financial markets, were 2.7 percent at most.

That is less than half the rise in May 2010, when a flash crash on Wall Street prompted a 6.7 percent rally in the currency.

YEN WEIGHT

The biggest weight dragging on the yen is the Bank of Japan's massive quantitative easing (QE) programme, under which it injects almost $70 billion a month into the financial system, or the equivalent of 70 percent of new Japanese government bond (JGB) issuance.

Japanese Prime Minister Shinzo Abe has said that his so-called "Abenomics" plan to spark sustainable growth and decisively beat the country's chronic deflation is not explicitly aimed at weakening the yen.

Instead, the yen's drop of about 19 percent against the dollar since late 2012 is a natural consequence of the BOJ's unprecedented monetary easing, set up to generate inflation of 2 percent within two years.

The higher import costs resulting from a weaker currency has in turn eroded Japan's balance of trade, further undermining the yen. Japan's current account, the broadest measure of a country's trade with the rest of the world, logged a record deficit in November, a second straight month in the red.

"One reason that made the yen a safe haven was Japan's current account surplus. But the surplus has disappeared, which means any buying stemming from that factor has weakened considerably," Citigroup's Takashima added.

While economists say the current account is likely to return to surplus in coming months as the country's income balance remains strong, most agree the surplus will decline long term.

LOW RATES

To be sure, one factor that could help the yen keep some of its safe-haven status for another year or so is that whenever investors' aversion to risk rises, their knee-jerk reaction is often to seek currencies with low, stable interest rates, which are often used as funding currencies for riskier bets.

Three-month money in Japan is indicated at less than 0.06 percent in financial markets.

Therefore, the same monetary policies that set the yen on its long-term downward slope could also add to its short-term appeal in times of market anxiety, to the extent that the BOJ is able to maintain stability in the JGB market.

So far, the BOJ's asset purchases have effectively kept a lid on JGB yields. The yield on the benchmark 10-year JGB has stuck to range of 0.580 percent and 0.740 percent since September, and is now around the midpoint of that band.

The BOJ has vowed to keep pumping liquidity into markets until its policy target is reached. Japan passed the halfway mark towards its 2 percent inflation goal in November, but many economists and market participants question whether the BOJ can meet its goal in its two-year time frame.

Naomi Muguruma, senior strategist at Mitsubishi UFJ Morgan Stanley Securities, said BOJ Governor Haruhiko Kuroda "sounds very confident" about reaching the target in two years, but markets were less convinced.

"As long as the BOJ maintains QE, that means the BOJ continues to purchase JGBs in a large amount every month, so that helps the JGB market remain stable," she said.

(Editing by Nachum Kaplan and Neil Fullick)