The market only cares about American yields

THE currency market just doesn’t care about Japan at the moment. It didn’t even flinch when Monday’s third quarter GDP figures showed that its economy is expanding at a whopping annualised pace of 3.9 per cent. It just wasn’t interested in the fact that the manufacturing sector was boosted by the mass purchasing of air conditioners – not one bit. It’s all about the dollar at the moment. Or US bond yields to be more specific.

Ten-year US bond yields have – somewhat unexpectedly – hit a three-month high. Everyone was expecting bond prices to rise and yields to fall after the second round of quantitative easing (QE), but now the opposite has happened, traders are linking the change to the rise of the dollar against the yen.

“For as long as US bond yields are going up so will the dollar,” says Michael Hewson of CMC Markets. “It’s a dollar story and it could be for a while.” So confident, he has his sights on a target of ¥84.20, heading all the way back to the 200-day moving average, and then maybe even returning to the giddy summer heights of ¥88.00.

QE CHEERLEADERS
So what will keep the bond yield rising? QE’s cheerleaders say that the market has been given a fright from Richmond Federal Reserve president Jeffrey Lacker’s comment that the Fed might need to tighten monetary policy and a strengthening campaign against QE. This – they suggest – means that the amount of QE already announced could be reduced. The reality for the bond yield is probably more complex.

Kit Juckes, a forex expert at Societe Generale, pins the unexpected rise on those who believed “the world was ending” in the lead up to QE and bought bonds at low yield. Late entrants who bought at the height of bond prices are now bailing out of the trade. Now the world has not ended and the economic indicators are looking more robust, these doom merchants are pulling out of bonds and looking for a better return. The knock on effect is that the yields are rising despite the Fed’s intervention.

But be warned, Juckes says he doubts this will last long: “This is a short-term watershed for Japan, soon the fate of dollar-yen will rest on the performance of the Asian conomies. I know this doesn’t correlate to the US bond yield pattern, but correlations are made to be broken.”

So the bullish on dollar-yen should go long on the pair for the meantime, but bear in mind that the factors in play will not be around for forever. Choosing your exit will be the challenge.