Currency analysts and carry traders have been looking with new interest at what the FT’s John Authers calls “El superpeso“, amid predictions that the steam could be running out of some of the forex industry’s favourite carry trades, not least around the Japanese yen.
It has all been bit iffy with the yen lately, which has started the week at an anaemic Y110.27 to the dollar, slightly weaker than last week.
As Lex noted recently: “The changes in currency markets have been large and fast. The big question, of course, is whether they will be sustained. While that mostly depends on commodity prices, the fading allure for yen investors of buying over-valued foreign currencies with shrinking yields suggests they almost certainly will be.”
But on an oblique and related front, Japan has been making some quiet moves on corporate tax regulations that could have a significant impact on the yen – further down the road.
Japan’s Nikkei newspaper on Sunday reported progress on a government proposal to change the tax status of dividends which domestic companies receive from foreign affiliates – and Tohru Sasaki, JPMorgan’s ever-vigiliant currency strategist, is onto it.
Sasaki earlier this year said the proposal would result in relatively large yen-buying by Japanese exporters. The latest government figures show that retained earnings at overseas affiliates of Japanese companies amounted to Y17,200bn ($156bn) at the end of fiscal 2006 (March 2007). This suggests that by now, retained earnings at Japanese overseas affiliates could have already reached a robust Y20,000bn, notes Sasaki.
In May, JPMorgan conducted a survey of 24 large Japanese corporates whose overseas affiliates have retained earnings. Although most lacked concrete plans, six corporates out of 24 rated the likelihood they would repatriate their overseas retained earnings if the tax system changed at more than 70 per cent.
Sasaki used the probability of repatriation for each corporate as a weight and calculated the potential amount that Japan Inc might bring in from off-shore operations under a revised tax regime. Lo and behold, the tentative conclusion was that 20-30 per cent of retained earnings would probably be repatriated, equal to about Y4,000bn-Y6,000bn ($36bn-$54bn) of yen purchase. If the tax change materialises (and the Nikkei newspaper predicts it will by next April) it’s likely to have what Sasaki calls a “meaningful impact” on Japanese yen, “considering Y4-6 trillion is larger than Japan’s trade surplus in the first half of this year (Y3.7 trillion)”, he said in a client note on Monday.
We think the probability of tax system change taking place in next April is relatively high. Some corporates may start hedging their exposure a few months earlier, once they become 100 per cent sure the tax system change is taking place.
Although this looming yen-buying flow won’t have any impact on the forex market this year, it is bound to make waves further down the line.