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BNP PARIBAS Markets Call Summary - Japan: Asset Outlook Amid a Rising JPY

Core Content

BNP Paribas provides a weekly cross-asset market view, focusing on Japan's economic and financial landscape amid a rising Japanese Yen (JPY). The report outlines the current state of the economy, monetary policy, and investment opportunities, particularly in equities and foreign exchange.

Main Points

• Global Risk Appetite: Risk appetite is gradually recovering, with most risky markets returning to the middle of their 2018 trading range. However, volatility is expected to remain higher than at the start of the year.

• USD/JPY: The USD/JPY pair has recently declined, even as US yields have risen. Japanese investors are likely to be key drivers of this yen appreciation. The BoJ is expected to maintain its policy of keeping 10y JPY yields below 10bp, and a stronger JPY could further support this stance.

• Japanese Equities: Japanese equities are supported by both domestic and foreign investor inflows, as well as the global recovery in earnings. However, a stronger JPY could be a headwind for equities due to the pressure on foreign earnings. The report highlights that some equities may benefit from labor reform, while others may suffer from wage pressures.

• Monetary Policy: The BoJ is unlikely to adjust its policy in 2018 due to limited inflation pressures. The economy is running close to full capacity, but structural rigidities and an expanding labor supply are limiting wage growth and inflation.

• Interest Rates: The BoJ is expected to keep 10y JPY yields low, which makes receiving 5s10s targeting 13bp attractive. Domestic investors' strong demand for JGBs supports 30y bonds, but an eventual rise in inflation and higher rates volatility could change this.

Key Information

• Economic Growth: Japan's economy has grown at an average of 1.6% y/y over the past two years, with output now above potential. The labor market is very tight, with the unemployment rate at a 20-year low and job vacancies at an all-time high.

• Inflation and Wages: Core inflation remains at 0.4% y/y, below the BoJ's target. Wage growth has been limited, with only part-time workers seeing significant increases. The increase in female and foreign workers has also dampened wage growth.

• Investor Behavior: Japanese investors have bought USD 1.4trn of foreign debt since 2014, mostly US fixed income. This could lead to further yen appreciation as they hedge their foreign assets.

• FX Volatility: USD/JPY volatility has declined to near 10-year lows, with a flat volatility surface despite a constructive risk environment. This makes long-dated USD/JPY options an attractive trade for investors who expect a gradual appreciation of the JPY.

• Labor Reform: The report identifies three sectors that could benefit from labor reform: human resources management, "consumption of experiences", and logistic solution companies. However, rising wage pressures are expected to impact companies with higher personnel expenses.

Trade of the Week

• Long JPY via USD/JPY options: Investors should consider buying long-dated USD/JPY calendars to limit carry/decay. The trade involves buying a 2y 101 USD/JPY put and selling a 1y 99 put for a cost of 3.04%.

• Short CHF/JPY via options: Shorting CHF/JPY is less negative carry than USD/JPY due to low Swiss yields. The trade involves buying 1y CHF/JPY 112 puts and selling 1y CHF/JPY 118 calls in a ratio of 1x0.5 for a cost of 1.19%.

Prognosis Overview

Sector Opportunities

• Labor Reform Beneficiaries: Companies in the human resources management, "consumption of experiences", and logistic solution sectors are expected to benefit from labor reform.

• Wage Pressures: Companies with larger personnel expenses for their profit size may face increasing cost pressures due to wage growth policies.

Market Outlook

• Yen Appreciation: The JPY is expected to strengthen against a structurally weaker USD, supported by Japanese investors' hedging activities.

• Equity Valuation: Japanese equities are trading close to fair valuation, with PEG ratios indicating this. The NKY implied dividend yield remains high, making equities an attractive alternative to fixed income assets.

• Inflation and Policy: The BoJ is unlikely to adjust its policy in 2018 due to limited inflation pressures. The JPY's correlation with risk appetite has weakened, allowing it to strengthen even in a risk-on environment.

Conclusion

The report highlights the importance of managing exposure to the JPY and Japanese equities given the current economic and monetary conditions. Investors are advised to consider long-dated USD/JPY options and short CHF/JPY strategies to capitalize on the yen's potential appreciation and manage volatility. The BoJ's policy stance and the structural factors in Japan's economy continue to shape the market outlook, with a focus on the long-term implications of labor reforms and inflation dynamics.