Wednesday, March 11, 2009

Making Sense Of The Yen's Rise & Fall

Readers will be familiar with my views on the yen. Yes, its an indicator of risk aversion although many more seem to regard the present yen's correction from 89 to 98 as more a reflection on the economic slump within Japan. Prior surge in the yen was driven by carry trade unwinding, a substantial shrinkage in US-Japan rate differentials, as well as the explosion in U.S. money supply versus static money supply growth in Japan. Beyond the unwinding of the carry trade, the yen’s fall also reflects worsening conditions in Japan’s export-driven economy and fears that the Bank of Japan will start flooding the market with funds to ward off deflation. It is very clear that Japan cannot operate lower than 90 yen to the dollar as most of their exporters have budgeted around 102-104 for 2009-2010.

It appears that Japan's finance mandarins still expect the strong yen phase, which as far as analysts can determine was caused mainly by a massive JPY20 trillion reversal of the yen carry trade. The yen has been a low-yielding currency ripe for funding carry trade positions in other higher-yielding assets. Some might say that the yen is falling because carry trade unwinding seems to have come to an end, not because the world is a safer place. That is a bit unfair to think that the yen's movements is mainly dictated by the carry trade. There was plenty of opportunity to unwind the carry trade, and which did happened, when the yen was moving around 110-115. The sharp gains which propelled the yen to 90 was a reflection of a flight to safe havens rather than a dramatic unwinding of yen carry trades.

Judging from the very low rates globally, the yen carry trade might not be the only popular transaction going forward. The USD carry trade or Euro carry trade might be the way to go. Plus both currencies have a bigger propensity to be largely weaker further down the road - a required recipe for a solid carry trade.

Figures from the Tokyo Financial Exchange (TFX) revealed that as of February 6, leveraged Japanese retail investors are now net long of the yen, meaning there are more buyers than sellers, for the first time since July 2006, when the TFX started posting positioning data. With the JPY’s status as a safe haven seemingly at an end – at least for the time being – it remains to be seen just how far it can fall. However, USD/JPY’s recent completion of a double-bottom technical pattern points to a near-term target of JPY 102-105. It can spike lower in times of extreme risk aversion, it cannot stay below 100 for long due to Japan's declining financial home bias; 110 for USD/JPY makes more sense than 90 over the medium-term. JPY/USD may fall below 100 in event of a dollar crisis, but won't stay there in the long-term due to:
1) economic decline from demographic shift,
2) large interest rate gap
3) yen failing to become key reserve currency
4) declining home bias of baby boomers

Put it another way, we need the Japanese economy to play its part to help resuscitate the global economy, and they will not be able to do well if it hovers at 90 or below. The weaker it is, the better it will be for the rest of the world.

p/s photos: Dhini Aminarti Maulana

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