Wednesday, November 28, 2007

Volatility and the Japanese Yen

From the FT this morning:

BoJ warns of ‘disease’ in world markets

By David Pilling in Tokyo

Published: November 27 2007 20:01 | Last updated: November 27 2007 20:01

The yen hit a two-and-a-half year high against the dollar on Tuesday as Toshihiko Fukui, governor of the Bank of Japan, expressed strong concern about the turbulence in world markets, comparing it with “a serious disease”.

The yen briefly rose to Y107.17 against the dollar, although it fell back to Y108 in Tokyo trading. Before July, when investors began to reverse some so-called yen carry-trade positions amid a retreat from risk, the currency had been trading at above Y120 to the dollar.

Tuesday’s sharp oscillations sent Japanese equity markets gyrating, with the Nikkei index falling 300 points in the morning amid concern about the effects of a strong currency on exporters, before it rallied to close up 87.64 points as the yen drifted down again. Mr Fukui said the volatile movements in financial markets since July suggested global markets were paying the price for “euphoria and excessive risk-taking”. It was the central bank’s job, he said, “to help markets adjust themselves in an orderly manner as far as possible, while keeping markets functioning at all times.”

The BoJ has reacted to the US mortgage crisis by putting an expected interest rate rise on hold, keeping overnight rates at 0.5 per cent. Although the bank has fractionally pared back its growth and inflation predictions for this year, it has stuck to its central thesis that Japan’s economy remains in a virtuous cycle.

Masaaki Kanno, chief economist at JPMorgan in Tokyo, said a strengthening yen clouded the picture. If the yen broke through Y100 or Y90 to the dollar, he said, it could “be a big blow to the economy” and once more raise the spectre of deflation.

“In the past we didn’t worry so much about yen strength as we believed the global economy would grow steadily,” he said. “But if the strong yen is caused by the slowing of the global eco- nomy together with the spread of risk aversion, then probably we should be a bit more worried than before.”

Other economists said concern about the yen comes on top of worries about the domestic economy, partly brought on by a sharp fall in housing starts.

Jonathan Allum, strategist at KBC Financial Products, said the yen was still relatively weak against the euro, a fact that had helped underpin strong exports to European countries.

On Tuesday, the yen, which peaked at Y168 to the euro in early July, had strengthened to about Y160, compared with previous levels of about Y130.

If the yen appreciated further against the euro it could damage exports to Europe, Mr Allum said. But the “knee-jerk reaction that a strong yen is bad and a weak yen is good [for Japan] is probably a bit out of date.”

Japanese politicians have said that a strong yen is not bad for Japan in the long run, but they have warned about the dangers of sharp movements.

From Bloomberg this morning:

The yen climbed against all of the world's 16 most-active currencies as losses at U.S. banks prompted investors to reduce purchases of higher-yielding currencies funded by loans from Japan.

The yen rose against the dollar, rebounding from its biggest decline in three months, after Asian stocks fell and Wells Fargo & Co. announced a $1.4 billion of loan losses. The euro fell after Germany's consumer confidence weakened more than expected by economists in December.

``The subprime crisis isn't over yet by any means,'' said Ryohei Muramatsu, manager of Group Treasury Asia in Tokyo at Commerzbank, Germany's second-largest bank. ``Investors are risk averse, so the bias is to buy the yen.''

Japan's currency climbed to 108.65 against the dollar at 6:50 a.m. in London from 108.97 late yesterday, when it fell more than 1.4 percent. The yen may rise to 108.10 today, Muramatsu forecast.

The euro declined to 160.52 yen from 161.62 yen and fell to a one-week low of $1.4773 from $1.4829, after Gfk AG's index of German consumer confidence fell to 4.3 in December, the lowest since January 2006.

The 13-nation currency also declined after the Economic Times of India today cited European Central Bank President Jean- Claude Trichet as saying he's averse to ``brutal'' shifts in exchange rates.

Growth Outlook

``European officials are worried the euro's gains may be excessive, hurting economic growth,'' said Tsutomu Soma, a bond and currency dealer in Tokyo at Okasan Securities Co., Japan's sixth-largest brokerage by sales. ``It looks like they don't want a rapid rise in the currency,'' which may fall to $1.4785 and 160.45 yen today, he said.

Losses in the euro accelerated after it dropped below $1.4775, where traders have orders to sell, said Shigetake Nakayama, a manager of proprietary trading desk in London at Bank of Tokyo-Mitsubishi UFJ Ltd., a unit of Japan's largest publicly traded lender by assets.

Traders sometimes place automatic instructions to limit losses in case their bets go the wrong way. The euro may fall to $1.46 against the dollar today, Nakayama said.

The euro has gained 2.7 percent versus the dollar in the past month, eroding the competitiveness of European exports. The European Commission this month cut its forecast for euro-area growth next year to 2.2 percent from 2.5 percent. The British pound weakened 0.3 percent versus the dollar to $2.0629, and the Swiss franc declined 0.3 percent to 1.1091.

The yen rose the most versus Norway's krone, a favorite of the carry trade because Norway's key rate of 5 percent is above Japan's 0.5 percent. The krone slipped 0.9 percent to 19.7886 yen. The MSCI Asia-Pacific Index of regional shares fell 0.4 percent.

Carry Trades

``Exporters are taking advantage of the yen's weakness, especially when the outlook of subprime problems is unclear,'' said Akihiro Tanaka, a senior currency dealer in Tokyo at Resona Bank Ltd., Japan's fourth-largest publicly traded lender.

Japan's currency may move between 107.80 and 108.80 per dollar today, Tanaka forecast.

In carry trades, speculators get funds in a country with low borrowing costs and invest in another with higher returns, earning the spread between the two. The risk is that currency fluctuations erase profits between the two rates.

Wells Fargo, the second-largest U.S. mortgage lender, said yesterday it will take a $1.4 billion pretax charge tied to increased losses on loans backed by homes.

The euro may fall to 153 yen after its chart formed a so- called ``double top,'' said analysts at Citigroup Global Markets Inc. Europe's single currency advanced to 167.65 yen on Nov. 7, with the previous peak a 12-week high of 167.74 on Oct. 15. The pattern indicates a currency may decline, triggering a slide in the euro to 153 yen, Citigroup's technical analysts said.

Japanese Exporters

Japanese exporters sold dollars before the end of the month on speculation the Federal Reserve's so-called Beige Book, a compendium of regional reports that will frame policy makers discussions when they meet in December, will today show mortgage defaults are slowing U.S. economic growth.

``The dollar has a downside risk with the Beige Book,'' said Masaki Fukui, senior economist in Tokyo at Mizuho Corporate Bank Ltd., a unit of Japan's second-largest publicly traded lender by assets. ``There are some possibilities the Fed may indicate the correction in housing markets and financial instability will adversely affect the real economy.''

The U.S. currency may decline to 103 yen by the end of March, Fukui said.

There's a 98 percent chance the Fed will cut its key interest rate by a quarter-percentage point next month from the current level of 4.5 percent, according to interest-rate futures traded on the Chicago Board of Trade. Investors saw an 82 percent chance a month ago.

and from Reuters

JGBs rise as quick remedy on credit crunch doubted

Japanese government bonds rose on Wednesday as investors remained doubtful of a quick resolution to global credit problems, with many financial institutions still struggling with losses from the slumping U.S. housing sector.

The housing market slump kept intact concerns about a deterioration in the U.S. economy, which could also weigh on Japan's economy and make the Bank of Japan delay raising interest rates further.

Traders said investors were buying back bonds, particularly in the medium-term sector, as they saw as overdone the previous session's sharp selling on expectations that money may flow into risk assets again from the safety of government debt.

JGBs and U.S. Treasuries fell sharply on Tuesday on news that Abu Dhabi Investment Authority, the world's biggest sovereign wealth fund, will inject $7.5 billion into Citigroup Inc (C.N: Quote, Profile , Research), which has been one of the hardest hit by subprime mortgage sector problems and the consequent credit crunch.

"The move is not sufficient to resolve the subprime loan problem, which has a much wider impact not only on the health of financial institutions but also on the U.S. economy, so selling of JGBs on the news was overdone," said a senior dealer at a big Japanese bank.

The move "soothed excessive pessimism, while few think uncertainties over the subprime mortgage problems have completely diminished," said Tatsuo Ichikawa, a fixed-income strategist at ABN AMRO Securities.

Wells Fargo & Co (WFC.N: Quote, Profile , Research), the second-largest U.S. mortgage lender, said on Tuesday it would take a $1.4 billion fourth-quarter charge largely related to losses on home equity loans as the U.S. housing market deteriorates.

December 10-year futures <2JGBv1> ended the day session up 0.21 point at 137.10, edging towards a 22-month high of 137.53 hit last week.

JGB futures have risen to their highest since January 2006, as turmoil in global financial markets has fuelled investor doubts over whether the BOJ will lift interest rates to 0.75 percent from the current 0.5 percent before the end of Japan's fiscal year in March.

The 10-year yield fell 1 basis point to 1.480 percent, staying well above a 26-month low of 1.395 percent reached last week.

The five-year yield fell 2 basis points to 1.025 percent. The yield slid to 0.995 percent on Tuesday, a 21-month low.

The two-year yield edged down 0.5 basis point to 0.755 percent. The short-term yield struck a nine-month low of 0.715 percent earlier in the month.

Traders expect the Ministry of Finance's offer of around 1.7 trillion yen ($15.67 billion) in two-year JGBs on Thursday to go smoothly, although demand is not expected to be very strong. Traders said the coupon could be set at 0.8 percent.

Weaker Tokyo shares also made investors careful about selling JGBs too aggressively, traders said. The Nikkei share average <.N225> ended down 0.5 percent at 15,153.78.

Japanese retail sales rose a more-than-expected 0.8 percent in October from a year earlier, pointing to firmness in consumer spending, but the data did little to alter the prevailing market view that the BOJ will not raise rates until well into next year. ($1=108.45 Yen) (Additional reporting by Rika Otsuka, Editing by Michael Watson)

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