Riding the yen roller coaster
Equity market volatility and global risk appetites will drive the yen in the near future.
Fresh concerns about the U.S. economy, centered around housing market woes, helped trigger the October equity sell-off (the 20th anniversary of the October 1987 crash might have played a part, too), which in turn decreased global investors’ appetite for risk — again — and helped drive the yen higher vs. the dollar. It’s like seeing reruns of your favorite television episode. When risk appetite in the global investment community rises, players move back into the carry trade, selling yen and buying riskier, highyielding assets. A decrease in risk appetite, however, sparks an unwinding these positions, which ultimately boosts the yen.
With interest rates at 0.5 percent in Japan, the lowest among industrializednations, analysts say the carry trade is not dead — at least not yet, anyway.
Sluggish growth conditions in Japan, with hints that deflation is still lingering, will likely constrain the Bank of Japan (BOJ) from “normalizing” interest rates anytime soon. As a result, when global investors find a renewed appetite for risk, they’ll likely step back into the carry trade, depressing the yen’s value. However, at the first whiff of volatility, financial market instability, or weakening economic news — especially relative to the U.S. — a massive unwinding would prompt the yen to spike up again.
Another factor is Japan’s political structure, which is so closely tied to its economy. A political shake-up at the helm of the Japanese government has injected uncertainty into the economic arena, including much-needed fiscal reforms. In mid-September Japanese Prime Minister Shinzo Abe of the Liberal Democratic Party (LDP) was forced to resign in the wake of his party’s devastating loss in upper house elections. However, the new Prime Minister, Yasuo Fukuda, has already lost popularity. A late-October poll by Mainichi Shimbun revealed public support for the new Prime Minister had dropped to only 46 percent, down 10 percentage points from the previous month, just after he hadassumed office.
“I worry he is a member of the old school,” says Tony Hughes, managing director of credit risk at Moody’s Economy.com in Pennsylvania. “He has been a minister in LDP government and his father was also an LDP prime minister. There are all these symbolic ties to the old school.”
The growth picture
Deflation still alive
However, the BOJ wants to normalize interest rates. If the Japanese economy were to slow significantly or even slip into recession, the BOJ would not have many tools to help jumpstart economic growth with interest rates at such low levels.
For now, currency strategists agree that economic and political fundamentals will have little impact on the overall action of the Japanese currency.
Dolan suggests forex traders monitor the VIX as a potential timing tool for yen carry trades.
BY CURRENCY TRADER STAFF