BOJ Lifts Rates

Good day. As widely expected, the Bank of Japan lifted rates 0.25 percent from almost zero, effective immediately. And as Chuck predicted, the yen dropped after BOJ Governor Toshihiko Fukui stated, “We don’t plan to raise rates consecutively.”

You could see it coming from a mile away. Fearing a dramatic increase in the value of the Yen with the end of ZIRP in Japan, the central bankers have been “prepping” the currency markets over the past week. After announcing the increase in the interest rates, the officials again fed the markets as much spin as possible to keep the currency from running up. Governor Fukui said the move to raise rates “was a forward-looking decision based on our commitment to keep prices stable and contribute to sustainable economic growth, rather than a response to an immediate overheating of the economy or inflationary risk.”

While the markets and news media have focused on the spin coming out of the BOJ, Chuck reminded me this morning that there’s a true distinction between the markets’ first reaction and the longer-term effects/consequences for yen. The important fact is that interest rates are going up in Japan and the economy is improving.

Not all of the BOJ members agree with the slower pace of rate increases. After digging into the official release, I read three of the nine board members advocated raising the discount rate, used for BOJ loans to commercial banks, to 0.5 percent. They were outvoted by the majority, who favored lifting it by 30 basis points to 0.4 percent. So there is obvious pressure from within to follow up this first rate increase with another, in spite of the “official” policy statement of no plan to raise rates consecutively.

The yen, which sold off slightly overnight, will likely start slowly increasing again after the economic data shows their economy is continuing to gain momentum. Growth in Japan is starting to come from inside, and not just from exports. Japan has the second largest economy in the world, so consumer confidence and an increase in demand will finally push the yen up. Patience is going to be the key for investors here, just as in Canada.

Chuck, who is in our nation’s capital this morning, sent me some thoughts to share with you this morning:

“You know, I’ve been a little hard on the Beaver this week (did you know the C$ / loonie is also called the “beaver”?). However, a reader from Montreal sent me a note that I found solace in: ‘Do not worry about the BOC games. They are only doing a short-term favor to the Canadian exporters to help them lock in hedging contracts at a decent exchange rate. It is good policy, and their claiming of no further increases only reinforces the option to lock better long-term hedges.’

“So, be patient, and you will see the BOC change track around September or October.

“The Mid East troubles are really heating up. And tonight, I saw oil trade over $78 per barrel! This is really gotten out of hand, and I can see a run to gold and Swiss francs!”

Lehman Brothers Holdings Inc. agrees with Chuck’s last statement. They advised clients to reduce bets on emerging market currencies and also told their investors to increase wagers on the Japanese yen after the BOJ move. James McCormick, Lehman’s London-based head of global currency research, said in a report yesterday, “The combination of a rate increase in Japan, anticipated hawkish comments from Federal Reserve officials and faster U.S. inflation seem too high a risk to be running large exposures in riskier currencies in the coming week.”

The markets seem to agree, as risk aversion is starting to creep back into the marketplace.  The Swiss Franc and gold have certainly benefited. The jump in the price of oil has also benefited the petrol exporting countries of Britain and Norway. The pound sterling was the biggest gainer among major currencies overnight, moving up nearly one percent. Oil prices will also continue to benefit Norway, which has one of the strongest economies of all of Europe. Investors who want some exposure to these currencies should look at our Viking Index CD, which includes three of the best performing currencies this year: Norwegian Krone, Swedish Krona, and Danish Krone. The Viking Index CD is up over nine percent so far this year and with these economies continuing to expand, we should see more good returns over the rest of this year.

The Chinese Renminbi was dropped overnight in response to the fall in the value of other Asian currencies. The People’s Bank of China set a lower reference rate for trading today, suggesting it wants the currency to move in line with the rest of Asia. If and when the Japanese yen is allowed to increase versus the U.S. dollar, we would expect the Chinese renminbi to match the increase and move along with the rest of its Asian competitors.

Many have predicted a dramatic move from China to mark the anniversary of the revaluation, but the Bank of China is playing this down. In fact, the Bank of China’s research director, Tang Xu, told this to reporters at a conference in Beijing today: “China has no such thing as a revaluation anniversary and the government is not planning further moves to mark the occasion.”

Currencies Today: A$ .7523, kiwi .6194, C$ .8846, euro 1.2668, sterling 1.8424, Swiss .8117, ISK 74.90, rand 7.207, krone 6.2469, SEK 7.26, forint 222.92, zloty 3.188, koruna 22.49, yen 115.82, baht 38.03, sing 1.5848, INR 46.37, China 7.9958, pesos 11.04, dollar index 85.99, silver $11.65, and gold $661.30

That’s it for today. Albert Pujols is the man! Another walk-off homerun in the 14th inning last night. The weatherman on the desk, John K., tells me we are going to have a heat wave here in St. Louis over the next week. I guess I will have to try and keep cool in the pool this weekend. Hope everyone has a great Friday and weekend!

Chris Gaffney
July 14, 2006

The Daily Reckoning