How The Yen Is Affecting Japanese ETFs

It's no secret that Japanese stocks and the yen often move in opposite directions. The inverse relationship was on display in the first quarter when the WisdomTree Japan Hedged Equity Fund DXJ and the CurrencyShares Japanese Yen Trust FXY moved in almost exactly opposite directions.

In the first three months of 2018, DXJ lost 5.8 percent while FXY jumped 5.4 percent. The other side of that coin is that when the yen falters, it's usually good news for Japanese equities and exchange traded funds such as DXJ.

What Happened

“When we look thus far at 2018, data from Japan’s Ministry of Finance has indicated that more than $30 billion has left Japanese equities from foreign investors,” WisdomTree said in a recent note. “Clearly, foreign investors haven’t been happy with Japan as an allocation, and a probable factor contributing to this activity is that people have seen the headline number for the Japanese yen/U.S. dollar exchange rate touching below 105 — quite a strong level!”

Year-to-date, DXJ is lower by 4.2 percent while FXY is higher by 3.1 percent. Investors have yanked $2.57 billion from DXJ this year.

Why It's Important

Those outflows from DXJ may prove to be hasty. The dollar is surging, up about 3 percent against a basket of major foreign currencies, including the yen, since the start of the current quarter. The inverse relationship between the yen and Japanese stocks is in full bloom in the second quarter, as FXY is lower by 3.1 percent since April 1 while DXJ is higher by almost 4 percent.

In 2018, the yen had been one of the strongest-performing currencies, despite the rise in the 10-year. In late April, the yen started coming under more pressure that coincides with the rise in U.S. versus Japanese yield differentials,” WisdomTree said.

Looked at differently, the Federal Reserve could raise rates as many as three more times this year, which could wind up benefiting DXJ.

What's Next

Some market observers are concerned the Bank of Japan is close to running out of tools with which to implement loose monetary policies. Yet it's unlikely the central bank there will seek tightening measures anytime soon.

As for DXJ, the ETF does not necessarily need an assist from Japan's central bank if the dollar rally continues with the Fed's own plans for higher rates.

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