Japan Benefits From Safe Haven Status as Europe Struggles

J-Money, August 2015

There are already signs that Japan’s markets may be benefiting from events in Europe.

Japanese assets appear to be gaining from a sense of being a safe haven, as Europe has once again been plunged into uncertainty over Greece. Although a Greek exit from the euro zone would not be disastrous, and would not cause a new global financial crisis, it would also not be healthy, and markets do not like the uncertainty that comes with the Greek question. Japan, by contrast, appears stable and its markets have been performing relatively well.

“Despite repeated criticism regarding fiscal waywardness, Japan has remained a financial safe haven, enjoying low long-term borrowing costs and a relatively stable currency,” says Govinda Finn, in Global Strategy at Standard Life Investments. “This largely reflects the country’s massive external net assets, which underpin the current account surplus.”

It is interesting to note, for example, that samurai issuance – bonds issued in yen by non-Japanese borrowers – had a very weak first quarter of 2015 (US$1.5 billion of issuance, less than a quarter of the amount in the first quarter of 2014) but started to revive once the latest Greek crisis gathered pace.

At the time of writing, Credit Agricole was preparing an innovative new samurai bond – combining subordinated and senior tranches for the first time – and ING was preparing to return to the markets with a pro-bond issue (a Tokyo Stock Exchange-listed structure, similar to a samurai but with less documentation requirements, and available to fewer investors). The British bank Lloyds priced its largest ever samurai deal in June, raising Y95 billion in total, with Peter Green, a senior manager in the bank’s funding team, noting: “Given the volatility we have seen in the euro market of late, the samurai market offered us – and other issuers – funding options at competitive economics to an investor base that wouldn’t participate in benchmark funding trades in other currencies.”

It was also notable that Apple issued the largest ever non-yen bond from an international issuer in June, with a Y250 billion debut global deal. Procter & Gamble, too, raised Y100 billion in late April. Both institutions achieved cheap pricing in yen compared to dollars, a combination of a number of things including Japanese investor appetite, the yen-dollar swap rate, and the fact that other international markets have turned cautious over problems in Greece.

Companies like these (Standard Chartered is another new issuer) are launching their bonds in Japan partly to diversify their sources of funding, but also because the Japanese markets have proven themselves to be predictable and resilient when things are uncertain in Europe.

At the same time, there seems to be growing confidence that things are going well in Japan. “Japanese equities have surged ahead since the start of this year despite lacklustre growth,” says Michael Stanes, investment director at Heartwood Investment Management. “Economic trends are starting to gather momentum more recently, but what is enthusing investors more is the perception that Japan is changing.” In particular, he highlights the arrival of Japan’s first corporate governance code on June 1, with the aim of improving transparency and accountability to shareholders. “Potentially, it represents a watershed moment because although the code is voluntary, companies are expected to be shamed into following best practice.”

Indeed, many international investors are watching Japan with interest ahead of its AGM season, to see if Japanese companies’ attitudes to investors, and Japanese investors’ attitudes towards companies, have changed as a consequence of the new governance code and the apparently increasing importance of shareholder relations.

Additionally, Stanes says the launch of the JPX-Nikkei 400 – the so-called ‘shareholder friendly index’, with a strong focus on return on capital – is encouraging Japanese corporates to strive to become better at providing value to shareholders.  Heartwood holds a active overweight position in Japanese equities, after having held a neutral position for 18 months.

Some think Japan has more to do. “The long-term challenge for the government remains: how to create stronger momentum among domestic consumers and businesses,” says Marino Valensise, head of Barings’ Global multi-asset group. “More Abenomics arrows are needed if the recovery is to spread beyond the export sector.”

And Finn at Standard Life says: “We think the government should be using the current cyclical upturn to launch a more credible longer term fiscal plan. This requires a major reform of spending and taxation practices.” Finn believes that a focus on growth at all costs is not sensible, and must be accompanied by fiscal soundness: an example would be the proposed rise in VAT to 10% in April 2017 being pushed still higher to 15%, the level the IMF believes Japan needs in order to move back to a strong fiscal footing.

Nevertheless, the mood towards Japan today is good – better than it has been for several years.

Asset flows to Japan are likely to be impacted by what happens next in Greece.

At the time of writing, Greece looked very likely to leave the Eurozone, having voted No in a referendum asking whether the Greek people wanted to accept the terms on offer for a further bailout package. It had missed a due IMF payment – the first developed country ever to do so – and appeared to be in risk of defaulting on a Eu3.5 billion bond owed to the European Central Bank on July 20.

If Greece does indeed lead the euro, world markets are likely to be affected, including Japan’s, but there will also be a flight to quality, which should lead to more assets going to top-end Japanese assets.

However a Greek exit is unlikely to be catastrophic for world markets or to cause a new financial crisis. Even in a Greek exit scenario, the Eu300 billion that has been lent to Greece by creditors has been factored in to investors’ thinking for several years now, and Europe is much stronger than it was in 2011 when the broader Eurozone crisis took place.

The other major political development in Europe – the UK election – is likely to have less of an impact on Japan, in that it delivered the same government as before, only much stronger and with an outright majority. Britain maintains its safe haven status for investors.

However, in order to win the election, David Cameron had to promise a referendum on EU membership, creating the possibility of a British exit from the Eurozone. While this will create uncertainty until the referendum is done – probably in 2016 – polling today suggests Britain is unlikely to leave.

If it did leave, then for a while at least, this might undermine the UK’s safe haven status, which might prompt financial assets to move to Japan. It would certainly be likely to damage Britain’s financial services industry. However, while it might affect asset flows, it is unlikely to have much of an economic impact on Japan, which would continue to have much the same trading relationship with the UK and the EU – separately or together – as it has today.

In conclusion, the combination of Japanese stability and European uncertainty is working well for Japanese markets today and is likely to continue to do so in terms of capital flows. But, in the end, Japan – like all world markets – will be rocked by a Greek exit from the Eurozone.