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GOVERNMENT FUELLING YEN STRENGTH

AS THE WEEK began, the yen continued its rampage through the currency market, hitting an eight-month high against the dollar on the first trading day of the week. I recently noted that since the greenback has become the prime funding source for the carry trade, the yen is no longer the whipping boy of the currency market and that’s part of the reason for its recent strength.

Another factor is the laissez-faire attitude of the newly elected Japanese government towards yen appreciation. At the start of this week Japan’s new Finance Minister Hirosh Fujii stated nonchalantly that the moves in the pair were “not abnormal”, effectively giving the go ahead for yen bulls to mercilessly short the dollar/yen pair without the fear of intervention hanging over the market. Clearly the new Japanese government has made a calculated decision that a pickup in global economic activity will help offset most of the negative impact of the rising yen for exporters while at the same time increasing the purchasing power of Japanese consumers which would stimulate domestic demand.

However, be careful what you wish for. The currency markets are notorious for taking price action to its extreme. The danger with this strategy is that the yen will appreciate much more quickly than Japanese fiscal authorities can imagine, forcing Japanese exporters to put on fresh hedges that could prove very costly. Most of the Japanese corporates are presently hedged around the 90.00-95.00 level, but if the dollar/yen remains below 90.00 for a considerable period they will have to initiate new trades. With dollar/yen having broken the 90.00 figure all focus will now shift towards the 87.20 double bottom set in December of last year. If yen longs can push the market through that level the drop towards the 85.00 barrier could be swift, triggering a cascade of stops that could quickly send the yen rally out of control. That’s why this week’s price action could prove to be pivotal for the yen. If the new Japanese government continues to stand idly by, the market may take the matter into its own hands.