That soaraway Nikkei and the yen Spot the outliers: That chart, from Nomura, shows the main driver behind the super soaraway Nikkei which is up 45 per cent since the start of the year - foreign investors. They have been buying up Japanese equities since last October to the tune of Y8.6tn. Domestic investors, mostly pension funds, have stood at the other side of the trade, selling Japanese and foreign equities. And that should be supportive for the yen, right? We've had a total inflow into Japan of more than Y3tn in March and April putting the Japanese trade deficit of Y1tn per month into context. But, say Nomura, the impact on the yen isn't clean and is probably counterintuitive (our emphasis): [W]e need to consider the impact of FX hedging to get a true sense of the net FX impact of the various equity-related flows: First, currency hedging by foreign investors when investing in Japanese equities will reduce the impact of fresh inflows on the yen. Second, hedge rebalancing in line with rising equity prices will also lead to JPY selling (simply to keep the hedge ratio constant for existing equity portfolio) We assume a 20% hedge ratio for foreign exposure in Japanese equities and 10% for Japanese exposure of foreign equities. These figures are based on company commentary as well as ad hoc surveys of selected real money clients. Meanwhile, we assume new flow into the Japanese equity market to be 50% hedged (a number broadly consistent with the distribution of flows into hedged and unhedged Japan equity ETFs: 57%). We assumed a lower hedge ratio for Japanese exposures as pension funds and retail investors (who do not hedge) have a larger share of foreign equities in Japan than elsewhere. To keep the hedge ratio at a constant level (20%), foreign investors have to sell JPY when Japanese equity prices rise (bigger exposure needs bigger hedging) and Japanese investors need to do the opposite. To simplify, we assumed the hedging adjustment happens every week although in reality the adjustment happens less frequently. That all means that foreign equity investors have most probably been net sellers of yen, not buyers - yen selling to keep the hedge ratio at constant has exceeded yen buying from new investment in most periods, say Nomura. Assumptions obviously matter, but unless you punt the hedge ratio down towards 10 per cent you still get net selling: On the other side again are the Japanese equity investors, who have been buying yen as they have been selling foreign equities and higher equity prices globally are assumed to require more FX hedging, which means yen buying. Nonetheless, Nomura estimate their pace of yen buying to be slowing as rebalancing by pension funds is slowing and equity performance outside Japan is less impressive than Japanese equity performance. So we probably have dominant yen selling overall and that could grow if Japanese equities stay bought and/ or foreign investors boost their hedge ratios. Nomura (who are Japanese equity bulls) estimate that a 5 per cent increase in the hedge ratio would amount to Y6tn of yen selling while if Japanse equity prices keep rising Y2tn additional net yen selling is possible to just keep the hedge ratio constant if Japanese stocks rally another 5 - 6 per cent. Not impossible. Opposite assumptions naturally apply and the relative performance of Japanese equities and global equities will also have an impact but it seems likely that right now, higher Nikkei means a weaker yen. God only knows what Akira Amari thinks about that. Related links: Assessing Abenomics - FT Alphaville JGBs: "Yes I would, Kent" - FT Alphaville Bird, plane, Abe - FT Alphaville Kyle Bass bets on full-blown Japan crisis - FT