from Follow the Money

The yen, for a change

December 4, 2005

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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The yen's trajectory at the end of 2005 seems a bit like the dollar's trajectory at the end of 2004.   With the yen at 120, companies like Toyota presumably have little incentive to ramp up their US production; the dollar/ yen still matters.  But, as General Glut notes, right now the markets are not demanding global adjustment, for better or for worse.  The yen is falling, despite Japan's current account surplus; rising home values are encouraging American households to take on more debt to support their current consumption

One reason for yen weakness: it seems like Americans playing the Japanese stock market want to hedge -- lest a falling yen wipe out their gains on the Nikkei's rise -- while Japanese investors playing the US bond market currently find hedging a bit too expensive.  

Steve Johnson of the Financial Times:

The Nikkei and yen now appear to be feeding off each other. A weaker yen plays into the hands of Japan's vast ranks of exporters, while the consequently higher Nikkei forces overseas investors - who have poured a net $270bn into Japanese equities since the spring of 2003 - to sell still more yen in order to hedge their rising Japanese equity portfolios.

The chief problem for the yen is that the flattening of the US yield curve has made it uneconomical for Japanese investors to hedge their ongoing purchases of US Treasuries, but a falling yen encourages overseas investors to hedge their purchases of Japanese equities - negating the value of these latter flows in currency terms.

The Nikkei has risen 34.2 per cent this year, but an unhedged US investor would have made only 16.6 per cent.

"Japanese life insurers and other investors have reportedly stepped up their buying of US Treasuries on an unhedged basis," said Marc Chandler, head of global currency research at Brown Brothers Harriman.

"[But] the yen's weakness has encouraged some foreign investors to hedge the currency exposure of Japanese equity investments, and as Japanese equity prices rise and portfolio values increase, such investors need to adjust their hedge ratio by selling more yen."

One thought: doesn't a big unhedged dollar position by private Japanese investors increase the odds that - should the yen/ dollar turn, Japanese investors may stampede to hedge against a weaker dollar?  That stampede, in turn, might amplify the initial market move.  At this stage, though, that is just a theoretical concern.  Japanese investors buying US dollar debt unhedged have had a very good year ...

Another thought: would this be a good time for Japan's Ministry of Finance to unload some of the dollars it bought back in 2003 and 2004? No need to worry about capital losses if you sell into dollar strength ...

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