Yen-Dollar Movements

The Mumbling Priest said...
Hi, saw this today from a Reuters article: "The dollar scaled four-year peaks against the yen on Monday amid expectations of strong U.S. economic data this week ..." "This week is make-or-break week for the U.S. dollar," said Kathy Lien, chief fundamentals analyst, at Forex Capital Markets in New York. "The foreign exchange market has turned very dollar-bullish after a series of upside surprises in economic data, causing a sharp plunge in rate cut expectations," she added. Dali, is this why the markets are down this morning? How would you interpret this?

For a mumbling priest, you sure don't sound like one. You have a couple of factors causing a sharp weakness in the yen and a corresponding uptick in the dollar:
a) yen carry trade - this is one of the newer terms created just to alienate the general public, a carry trade is borrowing in the currency and then converting it (selling) to invest in other assets (and different currency). Yen carry trades have been popular due to the very very low interest rates, and the mid term perception that the yen would not appreciate much. An example of a shrewd investing move, borrow in yen and paying 1% p.a. and investing in a well managed Singapore REIT for 6% yield - your risk is the interest rate differentials vis-a-vis the currency movements between the two - looks a safe play for a 1-2 year view.
b) US dollar shorters - undoubtedly, the dollar has been on a slide for much of 2006 and the first few weeks of 2007. The general consensus being that the dollar should slide some more in 2007. It was also thought that the slide would be as catalyst some weker economic data coming through for the US, and that the Fed would eventually have to ease rates sometime by mid-2007. Lower rates are supposed to be followed by a weakish dollar, hence the arguments go. However, despite rising inventory of housing, other economic data coming out of the US have indicated surprising firmness. This basically caused the expectations of a rate drop by the Fed to evaporate quite a bit. If rates are left unchanged for a bit longer, the dollar shorts would be wise to square off or reduce their positions, hence the sudden bullishness in the dollar.

To me, this is not a renewed bullishness, rather than a reversing of some shorts, thus compounding the yen carry trade. I have to state my position that the Japanese economy is recovering, and will continue its bullish run - a weaker yen will only help the cause not derail the momentum.

I do expect the BOJ to raise rates soon, and some may be alarmed by that, but seriously from such a low level, what do you want the BOJ to do? BOJ raising rates means a stronger domestic economy, a positive sign. It will also have the effect of reducing yen carry trade, but not so much, because at below 1%, the interest rate differentials is still substantial. However, once BOJ raises rates (and they will), the bullishness on USD will be tempered and the dollar should resume its slow slide.

The lack of a rate cut by the Fed will stop the bull run somewhat temporarily in the US for equities, but not by much. Its a both sides of the coin thing, no rate cut owing to firmer domestic economy, or rate cut due to a weaker economy. Both can find arguments for a continued bull run for equities. Fear is a hard landing, not likely with the current spate of economic data. Or uncontrolled inflationary expectations, not likely as well. So, no big risks here, bull is alive and well.