USD/JPY: Narrowing basis - Nomura
Ryoko Tada, Research Analyst at Nomura, notes that the USD/JPY basis swap spread reverted from its protracted widening trend and began to tighten in late 2016 (lower premiums for USD holders).
Key Quotes
“Factors behind the tightening of USD/JPY basis in terms of supply and demand.
“Below, we listed what we think are key factors behind the tightening trend:
1) Lower Japanese bank demand for USD in the basis market.
2) Slowing Japanese investor purchases of foreign bonds, which were aggressive until October 2016.
3) The sharp decline of Samurai bond issuance since February after a significant rise in January.
4) Expectations that the Trump administration would ease financial regulations.
5) The fading of the impact from MMF reforms in the US.
6) A halt in the decline in foreign currency reserves, which are large suppliers of USD.”
“Factors 1, 2 and 3 concern demand for USD, while 4, 5 and 6 are related to USD supply. Factor 3 is a short-term factor.”
“In addition, we believe the FSA’s special inspections of regional banks and the BOJ’s announcement that it would implement targeted bank inspections in FY17 led to expectations that banks would remain cautious in their foreign bond investments (qualitative factor).”
“Japanese investor purchases of foreign bonds (second factors) and Samurai bond issuance (third factor) may increase again to some extent, but we see more of the factors that served to widen USD/JPY basis have been changing, and therefore do not expect USD/JPY basis to widen again to levels seen in mid-2016.”
“Basis swaps should reflect the differences in business/investment returns between the two countries, which means USD/JPY basis should have tightened as credit spreads tightened more in the US than in Japan in H1 2016.”
“We attribute the widening of USD/JPY basis in 2016 to multiple supply and demand factors. The current tightening likely reflects the basis market correcting its supply and demand, the trend of which will likely continue, in our view.”