In December 1989 the Nikkei Index for the Tokyo Stock Exchange closed at 38,915.87. Nineteen years later it is at 8,512.27. The current Bank of Japan overnight call rate is 0.3%, the lowest central bank rate in the industrialized world. This benchmark Japanese interest rate has been at 0.5% or lower since 1996, including more than five years of zero rate policy while the Bank of Japan was fighting incipient deflation. Two straight quarters of negative growth this year have put Japan into an official recession. Despite its export prowess and the prevalence of its products in markets worldwide, Japan is not a thriving economy. 2009 could be an entire year of recession.
But if the economy is not thriving, the Japanese yen certainly is. Since the middle of last month, the trading range of the yen against the US dollar has been the strongest this currency has seen in more than twelve years. With the yen at a pronounced rate disadvantage, the Japanese economy sinking, and with a dismal record of growth for the country over the past decade one might well ask whether the fundamental measures of economic and interest rate comparison between the yen and its currency partners have been suspended.
Can the strength of the yen be laid solely to the collapse of the carry trade?
We have on occasion discussed the effect of the yen crosses on their constituent pairs: when the yen crosses rise, the euro gains against the dollar and the dollar gains against the yen; when the yen crosses fall, the dollar gains against the euro and the yen gains against the dollar. The reason for the rise or fall in the yen crosses is not overly relevant to the effect of the cross movement on the euro, the yen and the dollar. Regardless of the fundamental economic or interest rate differentials between the three currencies, their relationship has been dominated by the volatility in the carry trade crosses. More than any other factor the collapse in the yen crosses is responsible for the largest part of recent yen strength.
The depreciating euro jibes well with the real world situation of rates and economies. The Eurozone did not escape the general collapse in world markets and economies. The precipitate fall in the euro was triggered by the ECB acknowledgement of that fact and the overnight change in its rate policy from anti-inflation tightening to easing for growth and financial stability. The euro has fallen against the dollar because the prior set of assumptions, an immune Eurozone and restrictive ECB rates were false. The euro had to fall to adjust to the new circumstances.
But in the yen case the correlation between the real world of rates and economic performance and the strength of the currency is very weak. The yen has appreciated to heights not seen in more than a decade with the lowest central bank rates in the developed world, little expectation of higher returns and an economy not only in recession but which seems to have lost the knack of strong economic growth.
The unusual situation of a currency trading against its fundamentals for a prolonged period has been brought on by the financial turmoil of the past year and the deleveraging of market participants. The yen crosses were such a steady and favorite currency bet that when the end finally came the exit for many traders was catastrophic. It was not only the dangerous volatility that forced liquidation of positions but many of the players themselves were forced to limit exposure by reductions in credit lines and losses in other markets.
But despite the losses in the yen carry the trading ethos of the yen crosses has been maintained. They are the first to react when news hits the market. When financial market risk re-emerges the yen crosses are sold, they are said to be ‘risk averse’ and when relative calm supplants the nervousness, the crosses return to favor, or the market is imbued with ‘risk appetite’. This trading reaction has remained intact even if its logical connection to economic fundamentals has dissipated.
Where does all this yen cross action leave the yen? The direction of yen participation in the currency moves of the past year has been determined almost completely by the yen crosses. But how long will traders pass over interest rate and economic factors and the remarkable recovery the dollar has made against all of its other currency partners? Notwithstanding the old line about markets remaining irrational far longer than you can remain liquid, this particular irrationality probably has it limits.
It was the financial crisis and its attendant credit contraction that put the yen crosses in the forefront of the currency markets. The financial market volatility is not permanent and neither is the credit crisis. As the emphasis leaves the crisis arena the disparity between the Japanese economic and interest rate fundamentals and the current yen strength will come to the fore. The yen is due for a fall.
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This article has 4 comments:
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constructe
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357 Comments
Dec 02 05:28 AMRight now what is the Fed and treasury doing? The more they bail out the bigger the demand for treasuries. Why? Because they pretty much have caused panick and have confirmed that the only safe haven is in US treasuries which does the opposite of what they want. No one wants to buy anything else. And as they issue more treasuries to back bad debt that just means more people who want security can buy them. Soon no one will want or own anything but treasuries. How does that help? It doesn't. Wake up Fed and Treasury and read a economics book sometime. After all you are suppose to be professionals.
So far all I see is absolute incompetence. If the banks are safe, then why are you giving them all $. If they aren't, why aren't you forcibly making them transparent and cleaning them up rather than watch them hemorrhage CDS and CDO liability for 10 or 20 years as the economy declines to the stone age.
To the Treasury and Fed: Fix the mismanaged banks, insurance companies, and brokerages and stop trying to fix the consumer! That is, after all your job. Not finding out how to make the average US citizen borrow and then go bankrupt.
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KIT
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17 Comments
Dec 02 06:01 AM-
Mowog
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67 Comments
Dec 02 10:15 AMIt's nice to be holding yen now, but I don't know for how much longer. There are two online forex firms advertizing heavily on TV on the Tokyo area. People are lining up at banks--it's been on national news--to buy apparently cheap forex in banks in expectation of a profitable reversal later.
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constructe
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357 Comments
Dec 03 04:14 AMAnd yes it took over a decade for the Japan Post to privatize and yes it still is basically a government monopoly and acts like one. The government run US hangover intervention is looking as bad or worse than Japan's bought with it. Once the Euro goes to 0 if they don't do what the US is doing maybe start bulking up on the Euro. Although they are favored to duplicate the US. The only thing that may moderate it is infighting and bickering among the EU nations. Checks and balances work...lol.