IB FX View

Yen lifted by conflicting winds

Monday August 31, 2009

The Japanese yen strengthened on new found optimism rooted in decisive victory for the Democratic Party of Japan who rose to power on a platform of social and economic change. The news was accompanied by a reversion to pessimism in China where continued concerns over excesses in both lending and production capacity have fuelled a reversal in the stock market leading to a monthly close in official bear territory. Either way the clear direction at the start of a new trading week was for a stronger yen bolstered by a return to risk aversion.


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There are two elements behind the thought process that the DPJ’s election victory might be yen positive. The decisive victory saw the party, which has largely been in opposition for over half a century, sweep 308 of the 480 lower-house seats in Parliament. The Japanese have become more than just disenchanted with a political system that wrapped itself up in bureaucracy and became rather outward looking as the economy collapsed.

The DPJ has promised to spend more money to help end the recession. Spending on childcare programs is intended to boost the desire to raise children. One of Japan’s major problems is the aging population that will require heavy social spending going forward and currently there is a large hole in the support plan going forward. The nation simply doesn’t replace itself. Revitalizing the economy will require a large spending program and optimists point to this sea-change as being a huge plus for economic prospects.

The ruling Liberal Democratic Party was extremely cautious about yen strength on account of its reliance on Japanese manufacturing exports. Of course a rising yen means it’s more difficult for them to cope with overseas demand. But the yen is rallying today in part because the new expectation is for a lack of concern over the exchange rate from the DPJ. They would prefer to stimulate the economy internally and revitalize it socio-economically and watch the fruits of their policy flourish without reliance on that single export sector. They are less likely to be worried over yen strength and will likely speak out when the currency appears strong.

The yen rose to a seven-week high at ¥92.77 against the dollar and a six-week high against the euro. One euro today buys ¥132.84, while the dollar has regained some of its poise especially in light of declines in global stock indices today and stands at ¥93.00. The dollar index has risen marginally to 78.48, which compares to a low point of 77.52 coincident with the peak in global stock values at the start of August.

The dollar rose against the euro and stands at $1.4285, despite perhaps less uncomfortable news over Eurozone consumer prices. The CPI declined at a 0.2% pace in the year through August, which while less than feared is a distinct improvement on July’s 0.7% pace of decline. No one wants to see a regime of declining prices manifest itself. The euro also rose against a weakening pound and today buys 88.04 pennies. A report on British home prices compounded what we thought we were seeing earlier in the summer. Home prices rose marginally last month but the reality is that a 12% annual pace of decline is bringing fewer homes on to the market. The pound is also weaker at $1.6226 versus the dollar.

The Shanghai composite closed down 6.7% to start the week after it spend much of the prior week rebounding from what was a 20% retracement from its early August zenith. However, those ongoing concerns over too much lending and too much production at cement, steel and other industrial facilities, resulted in capitulation Monday. The most negative point is that the decline now represents a monthly close in bear territory. Typically technical analysis uses a 20% reversal from a peak to define onset of bear markets.

The second-round effects were clear as Pacific and European stock markets fell, while crude oil and metal markets also buckled. To start this week the American markets are also in retreat. Unlike the episode of a couple of weeks ago when American equities fell in Pavlovian style, this round feels like it may have more substance.

In that sense, it’s surprising that the U.S. dollar isn’t stronger than it already is. The Canadian dollar is well off its August peak and currently buys 90.62 U.S. cents while the Australian dollar, fully prepped for an RBA meeting later in the week, is also lower at 83.82 cents.

Andrew Wilkinson                                                                    

Senior Market Analyst                                                               ibanalyst@interactivebrokers.com       

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