The Future of the Yen

From Bloomberg today:


Yen Summer Fling Ending as Japan Economy, Rates Slow

The yen's seven-week rally is about to end.

New York-based JPMorgan Private Bank and Mitsubishi UFJ Asset Management Co. in Tokyo say they are selling the yen because five straight months of declining consumer prices will delay an increase in interest rates by the Bank of Japan, the one thing that would justify further gains. A government report today showed second-quarter economic growth slowed more than expected.

Gross domestic product eased to less than a third of the first-quarter's pace and a global credit crunch may make it harder for the Bank of Japan to justify raising borrowing costs from 0.5 percent, the lowest in the world. In the yen's first failure to rise last week since the five days ended July 6, the currency fell 0.3 percent to 118.40 per U.S. dollar.

``There are no Japanese reasons for the yen to rally,'' said Robert Robis, an international fixed-income portfolio manager at OppenheimerFunds Inc. in New York, which oversees $250 billion. ``The economic data are looking worse, not better. Without consumption or inflation picking up, it is hard to justify a BOJ rate hike.''

Since its low this year of 124.13 per dollar on June 22, the first full day of summer in the Northern Hemisphere, Japan's currency has risen 4.6 percent against the dollar. Of the 16 major currencies, only the Swiss franc's 2.55 percent gain comes close to the performance of the yen. The yen was at 118.36 at 7:40 a.m. in London

The economy expanded at an annual rate of 0.5 percent in the second quarter, below the median estimate for a 0.9 percent gain by 27 economists in a Bloomberg News survey, and down from 3.2 percent growth in the first three months of the year. The International Monetary Fund in Washington last week forecast that Japan will have no inflation this year.

`Bigger Picture'

The chance of a quarter-percentage-point rate increase at the BOJ's next meeting on Aug. 22-23 fell to 32 percent today from 52 percent a week ago, according to Credit Suisse Group calculations based on contracts for the exchange of interest payments.

``The bigger picture is still for the yen to weaken,'' said Paul Barrett, chief foreign-exchange trader at JPMorgan Private Bank in New York, which manages $422 billion and is a unit of JPMorgan Chase & Co., the third-biggest U.S. bank.

Short positions by Japanese investors, or bets the currency will weaken, have increased to a daily average of more than $23 billion this month, above the daily average of $21 billion in July, according to Bloomberg calculations based on the Tokyo Financial Exchange.

Even with last week's decline, the yen is still stronger than the average quarter-end forecast of 43 economists surveyed by Bloomberg over the past month. The median estimate is for the yen to weaken to 121 per dollar by October.

`Good Opportunity'

The current level of the yen ``offers our retail customers a good opportunity'' to bet on further weakening, said Junya Ota, who oversees the equivalent of about $7 billion at Mitsubishi UFJ, a unit of Japan's largest lender by assets. He predicts Japan's currency will weaken to 125 per dollar this year.

The yen reached 117.19 on Aug. 6, the strongest since March 20, as losses in securities tied to U.S. subprime mortgages and corporate bonds roiled global financial markets. Such turmoil tends to help Japan's currency because investors buy yen to repay low-interest loans that are used to invest in higher-yielding, riskier assets in other parts of the world. The strategy is known as the carry trade.

``The subprime fear just won't go away,'' said Samarjit Shankar, director of global strategy for the global markets group in Boston at Bank of New York Mellon Corp. The company is the world's largest custodian of financial assets, with more than $20 trillion under administration.

Relative Yields

Japanese investors can earn at least five percentage points more in yield with government bonds of Australia, New Zealand and Brazil, economies that are expanding as China and India buy more of their commodities. That will cause investors and traders to return to the carry trade.

``The relative interest-rate differential is still going to be big enough to bring people back to the carry trade,'' J.P. Morgan's Barrett said.

Shoal of Fish

The carry trade has produced better returns than the world's three-biggest stock markets. An investor who sold yen and bought Australian dollars at the start of the year has earned 10 percent, according to Bloomberg data. Buying the Brazilian real with money borrowed in yen returned 17 percent. Benchmark rates are 6.50 percent in Australia and 11.5 percent in Brazil.

By comparison, the Standard & Poor's 500 Stock Index has risen about 2.5 percent, Japan's Nikkei 225 stock index fell 2.7 percent and the FTSE 100 Index of stocks in London, has dropped 2.9 percent. U.S. Treasuries have gained 2.7 percent, according to data from Merrill Lynch & Co.

``There's still money to be made'' in the carry trade, said Mark O'Sullivan, who oversees $2 billion of foreign exchange in London at Currencies Direct Ltd., an investment management company. ``However, the markets have become much more risk averse, and moves in the carry trades are like a shoal of fish turning en masse in an instant,'' meaning that the currency is likely to be more volatile, he said.