SYDNEY: The yen's steadiness against the U.S. dollar this year could be nearing its end, with Japan's currency likely to weaken should the country's giant public pension fund divert trillions of yen into overseas assets following an investment strategy review.
The boost to exports from a weaker yen could help provide a second wind for a Japanese economy whose recovery is in danger of stalling following a sales tax increase in April.
The Japanese economy contracted an annualised 6.8 percent in the April-June quarter to suffer its biggest contraction since the March 2011 earthquake and tsunami, as domestic demand, capital expenditure, housing investment and external demand all plunged.
The economy's weakness has raised questions whether, in order to cement a recovery, policymakers should risk giving another dose of Abenomics - a mix of fiscal and monetary stimulus and longer-term structural reforms aimed at revitalising growth and ending deflation.
While a weaker yen has not helped exports as much as expected over the past 18 months, analysts said that the benefits of a further depreciation would eventually have an impact.
After tumbling from 79.385 against the dollar in late 2012, when Prime Minister Shinzo Abe was elected to launch his stimulus measures, to a six-year low of 105.45 on January 2, the yen has since flatlined at around 102.00 for most of this year.
However, traders say the yen may retest the January low, which it hit in January, when the $1.2 trillion Government Pension Investment Fund (GPIF) changes its investment allocation targets.
While there is no set date for GPIF to unveil its new allocation strategy, analysts suspect it could happen soon after the fund's reform bill is submitted to the Diet in September.
Traders say GPIF will drive the depreciation by investing more money in overseas assets, which would involve it selling yen and buying foreign currencies.
OUTWARD BOUND
GPIF is under intense political pressure to invest more in higher-yielding risk assets rather than settle for the miserly yields that Japanese government bonds (JGBs) offer.
Currently, GPIF has an asset allocation target of 60 percent in JGBS and sources have told Reuters that is likely to be reduced to 40 percent, as money is are switched into Japanese stocks and overseas assets.
GPIF is expected to raise its foreign asset weighting target substantially from the current level of around 23 percent.
"Our basic assumption is the new allocation for the foreign securities in total will be 35 percent," said Yunosuke Ikeda, head of FX strategy at Nomura in Tokyo.
Including the three mutual aid associations that will merge into the GPIF next year, the total shift to foreign assets could be in the order of around 16 trillion yen, Ikeda said.
"That is very unlikely to be hedged in terms of currency exposure, so there will be yen-selling pressure going forward," he said.
And where the lumbering GPIF goes, other funds in Japan's 332 trillion yen pension fund industry tend to follow, analysts said.
Shusuke Yamada, chief Japan FX strategist at Bank of America Merrill Lynch in Tokyo, said the magnitude and speed of the shift into foreign assets would be a factor.
"In general, we think Japan's capital shift will generate foreign currency demand so we are bearish on the yen on the long term," Yamada said.
Trades to short the yen against the dollar could really take off if these events dovetail with clearer signs of when the U.S. Federal Reserve will start raising interest rates.
Any renewed selling could see the market first target 105.50 yen, a key support area that corresponds to the 61.8 percent retracement of its 2007-2011 rally from 124.14 to 75.31.
A break there could pave the way for a revisit of the August 2008 trough of 110.67.
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