How strong Japan's Yen will be?
Monday, 22 December 2008
A. F. M. Mainul Ahsan
ON November 17, Japan's Prime Minister Taro Aso declared that Japan had slipped into recession for the first time since 2001. Japan's GDP had contracted at an annual rate of 0.4 per cent in the three months up to September, its second consecutive quarter of negative growth. Japan's Central Banks, Bank of Japan (BOJ), on October 31, 2008 predicted that the increased sluggishness in economic activity would likely remain until around the middle of fiscal 2009 and, thus, it lowered Bank's target for the uncollateralized overnight call rate from 0.5 per cent to 0.3 per cent. Interestingly, in such a gloomy economic condition, BOJ declined to interfere in the market when the U.S.A. is "bailing-out" its economy.
But how long will BOJ allow yen to get stronger? Because, manufacturers in Japan are suffering not only for declining demand of their products but also a stronger yen is increasing their pain. On December 12, the dollar tumbled to a 13-year low against the yen as the dollar fell to as low as ¥88.12 - the lowest since August 1995. In fact, Yen gained 19 per cent against dollar, 26 per cent against euro, and 39 per cent against pound since January 1, 2008! But why is the yen getting stronger everyday against dollar, euro or the pound?
Three-month U.S. treasury's yield, which is considered as risk free, is beaten down as more and more investors are buying those. In a financial turmoil, investors run for cash, gold, treasuries rather than stocks or municipal or corporate bonds. The yen's rise is owed, in part, to its status as a safe haven - in turbulent times. Investors are moving money into the yen because Japan, with its $15 trillion in personal savings built up by the nation's chronic trade surpluses, is the world's largest economy after the U.S. Furthermore, Japan's banking system has limited exposure to the sub-prime crisis, even though it's in recession. So, one reason that yen is rising, is investors' flight to quality.
Another reason, many economists claim, is the abrupt end of yen-carry trade. Three conditions are usually necessary for the carry trade to thrive: a currency with low interest rates, low market volatility and plenty of trading liquidity, and Japan has provided all of them. For much of this decade, Japanese and foreigners borrowed money in Japan, where interest rates were near zero and money was therefore cheap. They invested that money in higher yielding assets across the world, from home loans in Hungary and Korea to equities in India. Much of the yen-carry trade was used in the form of currency options or other types of derivatives trading. However, no one knows for sure how large this outflow of yen was. Most analysts agree its size was in the hundreds of billions of dollars.
Now Investors have been unwinding their yen-based loans as part of a panicked flight from risky assets, e.g., Hungary home loans and India equities. Henrik Gullberg, a strategist at Deutsche Bank AG in London, says, "Basically what we're seeing is a complete liquidation of everything in emerging markets, and even in the emerging-market universe, is very vulnerable." Those panicked investors run into safer havens like the yen and the Greenback, i.e., American dollar, which is also rising against the euro and British pound.
Besides, the prospect of global recession has led central banks in many countries to cut interest rates, reducing the appeal of borrowing in Japan. For instance, South Korea cut interest rates by 1.0 per cent on December 11, its biggest one-day move ever.
Thus, another reason for the end of the yen-carry trade has been a narrowing in the gap in interest rates between Japan and other developed countries. For years, Japan's low interest rates were attractive enough to entice investors to borrow money here and invest it in countries with higher rates of return.
As this money flows back into Japan, analysts expect the yen to keep gaining. Tohru Sasaki, chief exchange strategist in the Tokyo office of JPMorgan Chase Bank says that his company's forecast is 87 yen to the dollar, but it could go as high as 80 yen.
The Hungarian central bank hiked interest rates three percentage points to 11.5 per cent on October 22 to protect its currency. On November 12, State Bank of Pakistan raised its policy rate from 13 per cent to 15 per cent. Iceland's central bank has raised its key interest rate to 18 per cent from 12 per cent on October 28. All of the above mentioned currencies have lost a substantial amount of financial resources against dollar and Euro. One might think that yen might flow to those countries. A strategist at Deutsche Bank's Henrik Gullberg again answers: "I don't think 6.0 percentage points will make the krona (Iceland's Currency) any more attractive … the only thing that'll improve the krona is a return of risk appetite, and there are no signs of this happening any time soon."
So, Japan's Economic Outlook hardly supports a stronger Yen. Yen is over-valued, and won't exist over-valued for so long. Japan's businesses are suffering because of stronger Yen. For example, Panasonic already reduced its forecast net profit for the year that ends March 31 by 90.3 per cent to 30 billion yen because of declining demand and stronger yen since stronger yen make exports expensive to consumers.
Group of Seven (G7) countries are also putting pressure on Japan to interfere in the market. Sooner or later, BOJ will flood market by yen, i.e., yen will lose its current stronger position against dollar or euro, to get out of recession and control the economy. And we don't have to wait too long to see when does the Bank of Japan (BOJ) interfere in the market.
The writer can be reached at
mainul.ahsan@ttu.edu
ON November 17, Japan's Prime Minister Taro Aso declared that Japan had slipped into recession for the first time since 2001. Japan's GDP had contracted at an annual rate of 0.4 per cent in the three months up to September, its second consecutive quarter of negative growth. Japan's Central Banks, Bank of Japan (BOJ), on October 31, 2008 predicted that the increased sluggishness in economic activity would likely remain until around the middle of fiscal 2009 and, thus, it lowered Bank's target for the uncollateralized overnight call rate from 0.5 per cent to 0.3 per cent. Interestingly, in such a gloomy economic condition, BOJ declined to interfere in the market when the U.S.A. is "bailing-out" its economy.
But how long will BOJ allow yen to get stronger? Because, manufacturers in Japan are suffering not only for declining demand of their products but also a stronger yen is increasing their pain. On December 12, the dollar tumbled to a 13-year low against the yen as the dollar fell to as low as ¥88.12 - the lowest since August 1995. In fact, Yen gained 19 per cent against dollar, 26 per cent against euro, and 39 per cent against pound since January 1, 2008! But why is the yen getting stronger everyday against dollar, euro or the pound?
Three-month U.S. treasury's yield, which is considered as risk free, is beaten down as more and more investors are buying those. In a financial turmoil, investors run for cash, gold, treasuries rather than stocks or municipal or corporate bonds. The yen's rise is owed, in part, to its status as a safe haven - in turbulent times. Investors are moving money into the yen because Japan, with its $15 trillion in personal savings built up by the nation's chronic trade surpluses, is the world's largest economy after the U.S. Furthermore, Japan's banking system has limited exposure to the sub-prime crisis, even though it's in recession. So, one reason that yen is rising, is investors' flight to quality.
Another reason, many economists claim, is the abrupt end of yen-carry trade. Three conditions are usually necessary for the carry trade to thrive: a currency with low interest rates, low market volatility and plenty of trading liquidity, and Japan has provided all of them. For much of this decade, Japanese and foreigners borrowed money in Japan, where interest rates were near zero and money was therefore cheap. They invested that money in higher yielding assets across the world, from home loans in Hungary and Korea to equities in India. Much of the yen-carry trade was used in the form of currency options or other types of derivatives trading. However, no one knows for sure how large this outflow of yen was. Most analysts agree its size was in the hundreds of billions of dollars.
Now Investors have been unwinding their yen-based loans as part of a panicked flight from risky assets, e.g., Hungary home loans and India equities. Henrik Gullberg, a strategist at Deutsche Bank AG in London, says, "Basically what we're seeing is a complete liquidation of everything in emerging markets, and even in the emerging-market universe, is very vulnerable." Those panicked investors run into safer havens like the yen and the Greenback, i.e., American dollar, which is also rising against the euro and British pound.
Besides, the prospect of global recession has led central banks in many countries to cut interest rates, reducing the appeal of borrowing in Japan. For instance, South Korea cut interest rates by 1.0 per cent on December 11, its biggest one-day move ever.
Thus, another reason for the end of the yen-carry trade has been a narrowing in the gap in interest rates between Japan and other developed countries. For years, Japan's low interest rates were attractive enough to entice investors to borrow money here and invest it in countries with higher rates of return.
As this money flows back into Japan, analysts expect the yen to keep gaining. Tohru Sasaki, chief exchange strategist in the Tokyo office of JPMorgan Chase Bank says that his company's forecast is 87 yen to the dollar, but it could go as high as 80 yen.
The Hungarian central bank hiked interest rates three percentage points to 11.5 per cent on October 22 to protect its currency. On November 12, State Bank of Pakistan raised its policy rate from 13 per cent to 15 per cent. Iceland's central bank has raised its key interest rate to 18 per cent from 12 per cent on October 28. All of the above mentioned currencies have lost a substantial amount of financial resources against dollar and Euro. One might think that yen might flow to those countries. A strategist at Deutsche Bank's Henrik Gullberg again answers: "I don't think 6.0 percentage points will make the krona (Iceland's Currency) any more attractive … the only thing that'll improve the krona is a return of risk appetite, and there are no signs of this happening any time soon."
So, Japan's Economic Outlook hardly supports a stronger Yen. Yen is over-valued, and won't exist over-valued for so long. Japan's businesses are suffering because of stronger Yen. For example, Panasonic already reduced its forecast net profit for the year that ends March 31 by 90.3 per cent to 30 billion yen because of declining demand and stronger yen since stronger yen make exports expensive to consumers.
Group of Seven (G7) countries are also putting pressure on Japan to interfere in the market. Sooner or later, BOJ will flood market by yen, i.e., yen will lose its current stronger position against dollar or euro, to get out of recession and control the economy. And we don't have to wait too long to see when does the Bank of Japan (BOJ) interfere in the market.
The writer can be reached at
mainul.ahsan@ttu.edu