JAPAN ISSUES CAN’T STOP YEN STRENGTH

DIRECTOR OF CURRENCY RESEARCH, GFT

ONE of the inviolable rules of speculative markets such as foreign exchange is that traders will push prices beyond all rhyme and reason as long as momentum remains on their side. Witness the price movements in the yen as markets opened for trade at the start of this week. The Bank of Japan (BOJ) announced an emergency meeting and traders quickly scampered to cover their dollar-yen shorts fearing some fresh policy action on the part of Japanese officials to stem the yen’s relentless rise. However, the moment the BOJ announced that it was simply expanding its quantitative easing program from ¥20 trillion to ¥30 trillion – a paltry sum in the grand scheme of things, the FX markets instantly sold the pair and pushed it well below the key ¥85.00 figure.

Japanese authorities are becoming increasingly exasperated with the markets as the yen continues to strengthen despite very lacklustre economic data. Japan’s GDP growth for the second quarter of this year was a disappointing 0.4 per cent versus expectations of 2.3 per cent. Contrast that against a 2.2 per cent from Germany or even a 1.6 per cent growth rate from the US. There is no doubt that on a fundamental basis the yen is grossly overvalued if not against the dollar then certainly against the euro.

Yet, Japanese fundamentals matter very little in the dollar-yen trade. The direction in the pair is not driven by any policy action out of Tokyo but by the economic developments in the US. As long as the currency market fears the prospect of a double-dip recession in the US, the pair is likely to push lower as US bond yields compress further. With a slew of US economic releases on the calendar this week the markets will have plenty of opportunity to form an opinion. Traders will look to the ISM manufacturing report and, most importantly, Friday’s update on the US labour market to determine if US economic conditions have deteriorated markedly. If the data is weaker than expected, dollar-yen will continue to push towards the key ¥80.00 figure and may even trigger a round of physical intervention from the Ministry of Finance as the final policy response from beleaguered Japanese officials.

Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read commentary at www.GFTUK.com/commentary or e-mail borisandkathy@gftuk.com.