All About the Yen

Good day… We have been waiting a long time, but perhaps our patience is finally paying off. The Japanese yen continued its march upward, turning in another stellar performance with a move below 117. I was speaking to an EverBank WorldMarkets customer the other day and told him the move below 118 was critical. The next resistance looks to be around 114.60, so I won’t be surprised if we see it gap down to this level in the next few days. Well it looks like the yen is on its way! If we see it breech the 114.60 level, the next major support looks to be around 110.

So what has made the markets finally take note of just how undervalued this currency is? Some of the move has been due to the unwinding of the carry trade. Despite Japan’s top currency officials’ attempt to downplay the impact of the carry trade, hedge funds and others have been leveraging up by borrowing the yen and buying higher yielding currencies for the past few years.

This trade has become so popular that there are actually ETFs that have been developed to take advantage of the carry. The massive amounts of money that have been wagered here are what have kept the value of the yen down for the last few years. But, as Chuck and I have been warning everyone, the more money placed into this trade, the bigger the move up for the yen once it is unwound.

Need proof that the recent move is at least partially due to the carry trade? The Japanese yen is the best-performing currency in the world this week. The South African rand and the New Zealand dollar (higher yielding currencies that have benefited from the carry trade) are the two worst performers in the week.

Another sign the carry trade is unwinding: The Swiss franc, another currency that is used to fund the carry trades is headed for its fifth straight week of gains versus the U.S. dollar. There have been massive bets placed by currency traders shorting the yen and franc. While the carry trade may not be totally dead, I have got to believe this recent move is only the beginning.

But the recent rally in the yen wasn’t solely due to a reversal of the carry trade. Japan’s household spending unexpectedly rose for the first time in more than a year, suggesting the nation’s consumers may have recovered an appetite for shopping. Spending climbed 0.6% in January, the statistics bureau said in Tokyo today. The jobless rate was unchanged at 4% the bureau said separately. Consumer spending is picking up, and with employment remaining relatively strong, we could see Japanese companies start to agree to raise wages later this year.

Also helping the yen, Eisuke Sakakibara, the former “Mr. Yen” at Japan’s Ministry of Finance, said it’s possible the central bank will raise interest rates in May rather than wait until parliamentary elections are held in July. When the Diet is in session it’s easier to raise rates because any criticism of monetary policy by the ruling Liberal Democratic Party will be countered by the opposition, Sakakibara said in a speech in Tokyo. While I like Mr. Yen’s hawkish stance, I don’t think the BOJ is going to rush to raise rates again in May as recent inflation data released in Japan shows prices are stagnant.

Now on to the other currencies. The euro gave back some of its recent gains overnight as a report showed that German retail sales fell more than expected in January, as consumers cut spending after a tax increase. Sales, adjusted for inflation and seasonal swings, slumped 5.1% from December. Chuck had written in past Pfennigs about the new VAT increase and the expected impact on the German economy. But after the fastest economic growth in six years and unemployment the lowest since August 2001, German retail sales will likely recover.

A recent report by Lehman Brothers Holdings Inc. will likely give some support to the euro. Lehman raised its forecast for the euro against the dollar because of signs the U.S. economy is weakening. The euro will rise to $1.35 by mid-year, Lehman said in a research note published March first. The firm had previously predicted the euro would trade at $1.33 at the end of June. The economic “backdrop for the dollar looks to be deteriorating once again,” Lehman currency analysts wrote in the report. “We remain tactically dollar bearish and are leaning towards further medium-run weakness as well.” It’s always good to welcome some of the big boys on our bandwagon.

And moving on to the United States, the huge amount of data released yesterday was largely negative for the dollar. Both personal income and spending increased slightly in January, and the PCE numbers showed that inflation is not increasing as quickly as previously thought. Initial jobless claims rose, and construction spending fell. Rounding out the data on the positive side, the ISM manufacturing index was higher than expected and the House Price index increased.

Today we only get the U. of Michigan consumer confidence number which is expected to be down slightly. Both Fed Chairman Bernanke and St. Louis Fed President William Poole will be speaking this morning, so we will be watching for any market moving quotes. I would expect both of them to lend some support to the dollar with speeches saying the U.S. economy is strong enough to keep borrowing costs on hold (no need for a cut in rates).

Currencies today: A$.7825, kiwi .6869, C$ .8522, euro 1.3163, sterling 1.9445, Swiss .8178, ISK 67.07, rand 7.3425, krone 6.1560, SEK 7.0590, forint 193.18, zloty 2.9641, koruna 21.38, yen 116.93, baht 33.65, sing 1.5259, HKD 7.8138, INR 44.2938, China 7.7460, pesos 11.18, dollar index 83.87, Silver $13.51, and Gold $660.85

That’s it for today… The end of a pretty wild week in the markets. Can’t say that I’m not just a little relieved we are finally seeing the yen move. Beautiful day here after those nasty storms came through yesterday. Coached my son’s Squirt hockey team to the finals of their end of season tournament last night, so I’m feeling pretty good today! Have a great Friday, and a good weekend!!!

Chuck Bulter — March 02, 2007

The Daily Reckoning