Is the yen's recent rebound driven by capital inflows rather than intervention? Norway's sovereign wealth fund may be shifting its fixed-income allocation from US Treasuries to Japanese Treasuries.

Is the yen's recent rebound driven by capital inflows rather than intervention? Norway's sovereign wealth fund may be shifting its fixed-income allocation from US Treasuries to Japanese Treasuries.

The yen is experiencing an appreciation unlike any other – this time, there is no central bank intervention, no government spending, but rather a genuine capital inflow driving it.

Last week, the US dollar fell sharply against the Japanese yen, a drop comparable to the two previous official interventions, but no significant rebound has yet occurred. Unlike previous instances, this appreciation is not a product of Japanese authorities' bond-buying operations. The Norwegian sovereign wealth fund, Norges Fund, is reportedly adjusting its fixed-income allocation, potentially shifting from US Treasuries to Japanese bonds, sparking widespread speculation about a return of international funds to Tokyo. Against this backdrop, the yen has remained around 154 against the dollar.

Analysts believe the yen's appreciation is sustainable. Anatole Kaletsky of investment research firm Gavekal described the yen as "the most undervalued major currency in modern history," noting that last week's rebound occurred after the release of strong US non-farm payroll data—data that has historically almost invariably led to a weaker yen and a stronger dollar. The Bank of Japan is expected to raise interest rates next week, with the market currently anticipating an overnight rate increase of a full percentage point to 1.9% over the next 12 months.

Short covering fires the first shot, capital inflows follow.

The recent appreciation of the yen was triggered by the forced liquidation of extremely crowded short positions.

According to Masayuki Nakajima of Mizuho Bank, leveraged funds' short positions in the yen were already at extremely high levels at the beginning of this month. While the official intervention in August was costly—resulting in the largest monthly drop in Japan's foreign exchange reserves on record—it still left behind a large number of vulnerable short positions. Once market volatility returns, many traders will be forced to reduce their short positions, thus creating the initial momentum for the yen's rise.

However, the deeper driving force stems from a substantial shift in capital flows. The news of Norges Fund adjusting its fixed-income allocation became a key catalyst, sparking speculation about increased sovereign-level capital inflows into the Japanese bond market. Meanwhile, Jesper Koll, corresponding author for Japan Optimist, points out that rising Japanese bond yields have already resulted in unrealized losses for the country's largest quasi-national asset managers—institutional investors commonly known as "whales"—potentially forcing them to sell overseas assets. Once these institutions convert their dollar assets back into yen, the appreciation trend will have even greater potential. This would be the first forced sell-off since 2011 (when it was triggered by foreign exchange losses).

Japanese Prime Minister's push for asset repatriation boosts the yen.

Japanese Prime Minister Sanae Takaichi has clearly stated her intention to channel savings back into the domestic market, a stance supported by the United States. Large institutions are responding to this policy signal.

From a macroeconomic perspective, Japan's inflation pattern is also quietly changing. Core inflation (excluding food and energy) has risen to its highest level in thirty years, although it is still below 2%. Market-driven inflation expectations have further reinforced this trend—the five-year breakeven inflation rate has remained above 2% over the past year, and the market is beginning to believe that Japan will follow the same inflation patterns as other economies.

More importantly, real wages have begun to grow positively, and nominal wage growth is at its strongest pace in decades—a fact corroborated by data from Mizuho Financial Group. Against this backdrop, the Bank of Japan's interest rate hikes may be more about preventing runaway inflation expectations than stifling the economic recovery.

The era of carry trades may be coming to an end, and global funds need to adapt.

For decades, Japan has been a source of cheap funding for the global financial system. Ultra-low interest rates and a weak yen fueled massive carry trades—borrowing yen and investing in high-yield assets worldwide. This logic is crumbling.

After years of serving as a cheap global funding currency, the yen is at a historic low. Measured by its real effective exchange rate against a basket of currencies, adjusted for inflation, the yen still has considerable room for appreciation. Kaletsky believes that the yen's rebound from this "absurdly cheap" starting point is far from over.

If Japan accelerates the repatriation of its overseas assets, other global markets will have to learn to operate without the support of cheap Japanese funds—this poses a significant structural pressure on trading strategies that rely on yen carry trades and on the US Treasury market, which has long benefited from Japanese buying.

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