CHF/JPY Trending Lower As Japanese Investors Hedge Their Overseas Assets

Marshall Gittler, Head of Investment research,

After peaking in June, CHF/JPY has been steadily declining (i.e., JPY has been appreciating faster than CHF).

The pair temporarily moved up when the Bank of Japan moved into negative interest rates, but that move has faded entirely. USD/CHF has been trending upwards (i.e., CHF has been weakening), while USD/JPY has been trending down (i.e., JPY has been strengthening). This is despite the fact that the two currencies are lumped together as the “safe haven” currencies, i.e. the ones that tend to appreciate when the world gets more risky.

I looked at the correlation of weekly moves in USD/CHF, USD/JPY, and CHF/JPY with various risk indicators from Feb. 2015 to now (following the Swiss National Bank’s abandonment of the EUR/CHF peg). The correlations of USD/JPY and USD/CHF have generally had the same sign, that is, they tend to move in tandem during risk-on and risk-off period. Both currencies are functioning as safe-haven currencies, although USD/JPY seems to be more highly correlated with risk than USD/CHF is. Note particularly the similar level of correlation between USD/CHF and the VDAX index, indicating higher correlation between CHF and European risk.

(The exception is the negative correlation between AUD/USD and USD/CHF. To be honest, I can’t immediately explain why CHF should appreciate when AUD is appreciating, too, and why the correlation there should be stronger than between AUD/USD and USD/JPY – any explanations gratefully accepted.)

Because USD/JPY and USD/CHF are both similarly correlated with risk, CHF/JPY has little correlation at all with most risk measures, except for a fairly strong positive correlation with AUD/USD.

If both JPY and CHF are risk-sensitive, why then is CHF/JPY trending so strongly? I think the explanation lies in the different reasons why these currencies are safe-haven currencies. For JPY, it seems to be investor hedging during risk-off periods. Japanese investors have huge overseas investments, which they hedge when they get nervous. Other investors apparently know about this trend and jump on the bandwagon. For CHF, it’s apparently a matter of capital outflows decreasing during risk-off periods, which tends to cause CHF to appreciate (Switzerland has a large current account surplus, which pushes up CHF if it’s not recycled).

Over the last several years, one of the major reasons why JPY depreciated was because of unusually large outflows into unhedged foreign currency assets. Led by Japan’s Government Pension Investment Fund (GPIF), the largest pension fund in the world (indeed the largest state investor in the world), Japanese pension funds have been moving out of low-yielding Japanese government bonds and into foreign bonds and equities in a massive overseas diversification. This has been an important part of PM Abe’s reform project. Now however as the yen starts to strengthen, fund managers are probably racing to hedge those positions. This is causing the yen’s gains to snowball.

CHF on the other hand seems to be still mean-reverting from the massive move a year ago, when the SNB pulled the rug out from under the market. Interest rates are deeply negative and the SNB has apparently been intervening in the market to weaken its currency. Furthermore, CHF is still tremendously overvalued while JPY is trading below purchasing power parity for the first time since the Plaza Accord in the mid-1980s.

I would therefore expect JPY to be a more effective risk barometer for the time being and for CHF/JPY to continue to fall during this risk-off period. A change in course could depend on Japan showing a similar appetite for intervention as Switzerland does. But Switzerland is a small country that can get away with actions that larger, “systemically important” countries can’t. I would expect to get some verbal intervention from Japanese officials, but in the current environment I do not expect them to begin actually intervening. We may therefore see further appreciation of the yen vs both USD and CHF.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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