November 25, 2008
Posted by: Joe O'Leary
"To paraphrase Winston Churchill's famous statement about
democracy, the floating exchange rate system is the worst possible
system, except for all others."
-Robert Rubin, former U.S. Treasury Secretary
This past week, the currency markets have found no shelter from
the storm that seems to part of the financial markets' daily
routine. The dollar continues to climb higher as weak economic news
pours in from around the globe. Last week, the United Kingdom
reported that retail sales fell again. The Bank of England is
signaling further interest rate cuts are likely on top of those
recently announced. The European economies are tanking as reflected
by Europe's recent gross domestic product numbers, confirming a
recession is in full swing.
The exception to the strong dollar (USD) is its value against the
Japanese yen (JPY). The JPY has actually strengthened nearly 15
percent against the USD since August and nearly 30 percent against
the EUR for the same time period. This strength is despite
disappointing Japanese GDP figures for Q3. Japan's economy, the
second largest in the world, fell into an official recession for
the first time since 2001 as GDP fell an annualized 0.4 percent in
Q3. In addition, the Bank of Japan policy board cut its target
overnight call rate by 20 bps to 0.30 percent at its October 31
meeting, the first rate cut in seven years.
One of the basic tools to judge a currency's outlook is to review
the economy's strength and relative interest rate environment when
compared to another currency. So why is the JPY so strong despite
its poor economic performance and near zero interest rates, which
are well below other major currencies? Is the Japanese economy so
much better than the European economies that it should be 30
percent stronger against the EUR in just four months? Despite all
the poor news in the U.S., is the yen really justified in
appreciating nearly 15 percent since August?
The answer to these questions is not so simple. When fear and
capital preservation are the overriding theme, risk aversion often
drives currencies in what seem irrational directions. Recently, the
yen has become an unexpectedly important barometer of investors'
appetite for risk worldwide. If investors get worried, the yen
often strengthens. Conversely, when investors are willing to go out
on a limb, the yen tends to weaken. In the past, risk-taking
investors were enticed to borrow cheap yen, and then invest the
borrowed money in other countries where returns can be higher -
often called the carry trade. Historically, this weakens the yen
because the borrowers are essentially selling yen to buy other
currencies, which in turn strengthen.
One of the key tools to gauge the value of the Japanese yen has
been the performance of the U.S. stock market, and the correlation
between the Dow, the S&P and the yen. As U.S. stock indices and
the value of my 401(k) get hammered, it proves disastrous for the
broader risk sentiment, and a flight to safety is producing sharp
Japanese yen and U.S. dollar strength. For the last several months,
investors clearly reduced their exposure to risk over a broad range
of assets, driving down investments from stocks to commodities, and
buying safe-haven assets such as U.S. Treasuries. Late last week,
U.S. T-bill yields are near zero, while the longer dates bonds saw
yields plummet on demand for the safety of U.S. government debt.
The Road Ahead
The next several trading weeks of the U.S. Dow Jones could prove
critical for both the global equity markets and foreign exchange
markets. There is a clear indication of risk aversion in the
markets that should continue to work in favor of Japanese yen
strength. As the global economy slips into a deeper recession, the
USD and JPY will continue to rise against every other currency
around the globe. In addition, there is still strong repatriation
demand for yen. As the Asian emerging markets slip, Japanese
investors will be bound to move capital back home, keeping the yen
rally intact. It is estimated that only one half of available funds
have been repatriated. The potential for more funds remitted back
to Japan is great, due to Japan's huge offshore investments.
The only glimmer of hope for the JPY to reverse this trend is good
old government involvement. Finance Minister Nagakawa and Japan's
Ambassador to the U.S. Fujisaki recently said the dollar should
remain the world's reserve currency suggesting that Japanese
officials remain concerned over the weak level of the USD-JPY.
Japanese exporters, from Toyota to Canon, are announcing profit
warnings as sales forecasts would fall on a global economic
slowdown and an overvalued currency. Any intervention may be offer
temporary support. However, we all know what government
intervention can present. In my opinion, 85 yen to the USD is
possible by mid-2009.
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Canary in a Coal MineOctober 22, 2012 Posted by: Joe O'Leary
"To paraphrase Winston Churchill's famous statement aboutdemocracy, the floating exchange rate system is the worst possiblesystem, except for all others."
-Robert Rubin, former U.S. Treasury Secretary
This past week, the currency markets have found no shelter fromthe storm that seems to part of the financial markets' dailyroutine. The dollar continues to climb higher as weak economic newspours in from around the globe. Last week, the United Kingdomreported that retail sales fell again. The Bank of England issignaling further interest rate cuts are likely on top of thoserecently announced. The European economies are tanking as reflectedby Europe's recent gross domestic product numbers, confirming arecession is in full swing.
The exception to the strong dollar (USD) is its value against theJapanese yen (JPY). The JPY has actually strengthened nearly 15percent against the USD since August and nearly 30 percent againstthe EUR for the same time period. This strength is despitedisappointing Japanese GDP figures for Q3. Japan's economy, thesecond largest in the world, fell into an official recession forthe first time since 2001 as GDP fell an annualized...Read More