Yen hedge ratio hits 14-year low! Expectations for Japanese life insurance industry remain subdued.

The Japanese life insurance companies' hedging protection against the appreciation of the yen for overseas assets has dropped to the lowest level in 14 years, indicating that the industry's expectation of the yen continuing to strengthen is weakening. According to the analysis of financial report data, in the first half of the fiscal year ending at the end of March, the nine major Japanese life insurance companies reduced their yen bullish hedge ratio for their foreign exchange investment portfolios from 45.2% six months ago to 44.4%. Despite the unpredictable policies of the Trump administration exacerbating volatility in the foreign exchange market, it has not been able to reverse the trend of the yen hedge ratio declining for three consecutive years. Currently, the policy interest rate of the Bank of Japan is still 3 percentage points lower than the domestic inflation rate, and the next rate hike may be further postponed. Ayako Sera, a market strategist at Mitsubishi UFJ Trust and Banking Corporation in Tokyo, said that the continuous decrease in the hedge ratio indicates that "life insurance companies believe that the possibility of the yen returning to its historical strength has decreased, and they tend to hold unhedged foreign bonds to maintain foreign exchange risk exposure. The fundamental reason is that the real interest rate of the yen is too low." However, unhedged positions have potential risks: once a foreign currency depreciates, the capital gains and income of overseas assets may be completely offset, which may prompt life insurance companies to urgently increase foreign exchange hedging, thereby exacerbating the depreciation pressure on foreign currencies against the yen. In March, due to the overall weakening of the US dollar, the index measuring the strength of the yen against major trading partner currencies reached a six-month high. However, as the Bank of Japan added trade policy factors to the list of economic and inflation outlook risks, the yen could not sustain its upward trend and ultimately fell by 1.6% in the first half of the fiscal year. With the Bank of Japan postponing the timeline to achieve its inflation target this month, the likelihood of a rate hike has further decreased. Overnight index swaps indicate that the market expects a 72% probability of a 25-basis-point rate hike by the end of the year. At the end of January, the market expected a 27% probability of a 50-basis-point rate hike for the entire year. Meanwhile, the swap market indicates that the Federal Reserve may resume rate cuts as early as September, with a probability of over 50%. Since hedging costs are mainly driven by the interest rate differentials between the two countries, a decrease in US interest rates will typically lower the USD hedging costs for Japanese investors. Based on this, Tsuyoshi Ueno, a research associate at NLI Research Institute, stated, "I believe that future demand for foreign exchange hedging will increase." Data from the Ministry of Finance shows that in the six months ending on March 31, life insurance companies net sold 756 billion yen of foreign bonds, marking the seventh consecutive half-year of net selling. In contrast, after net buying 1.06 trillion yen in overseas stocks in the six months ending on September 30, insurance companies net sold 21.2 billion yen of overseas stocks in the same period.