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Yen: Interventions likely?

Wed, Oct 7 2009, 12:24 GMT
by Erste Bank Bond Research Team

Erste Bank der oesterreichischen Sparkassen AG

Dollar remains under pressure

CHF still stable

Yen: Interventions likely?

US dollar

The US dollar has recently found temporary support in weaker-than-expected US economy data. The market was not following the rationale of interest rate expectations, but based its movements on the idea that the flow of capital was still profoundly determined by the willingness to assume risk. However, after the massive economic slump in the past twelve months, interest rate hikes seem so remote that a slightly better or worse indicator will hardly move expectations either way.

But most recently the US dollar has depreciated again. This was among other things due to the recovery on the stock exchanges, which indicated a higher risk appetite and thus less need for the safe haven of the US dollar. That said, the function of safe haven of the dollar has been on a sliding slope, as highlighted by the medium-term trend of the exchange rate. This has been caused by the extremely expansive policy of the US central bank – as frequently mentioned at earlier occasions – and by the rapidly rising level of public debt. The budget deficit for the current fiscal year might even exceed the 10% of GDP allowed for, given that most recently news about a possible new stimulus package of the US government has emerged. Representatives of the Eurozone are also concerned about a further depreciation in the US dollar. The weak dollar will be on the agenda at the G7 summit next Saturday. But it remains to be seen whether the various country representatives will be able to agree on one common statement regarding the US dollar. We continue to see the US dollar under pressure in view of the aforementioned factors. However, any massive weakening of the US dollar should be dampened by the fact that this would negatively impact the export-dependent Euroland economy, which would in turn undermine the attractiveness of the euro. But at any rate, the environment will remain negative for the US dollar for some time, which means there is always the risk that the US dollar will depreciate beyond our expectations.

Swiss franc

The franc is still being stabilized by the SNB. Until the next interim result from the SNB, the extent and timing of the interventions can only be guessed at. However, lately, remarkable intra-day movements of the exchange rate have been seen. We still think that the main focus of the SNB is the franc. Indeed, in a recent article titled “The Swiss Franc and the Financial Crisis,” SNB council member Jordan points out once more that the franc is perceived as very safe by the markets, implying safe haven flows in times of turmoil that need not reflect the economic evolution. Hence, it is of crucial importance to the economy that the SNB counteract such an “artificial strengthening”. In the future, too, we expect a stable exchange rate, and we think that the SNB will only make a policy change in the case that strengthening pressures abate significantly, and if a rate hike by the ECB is in sight.

Japanese yen

The strengthening pressures on the yen intensified during the last few days. Most likely, increasing exports, the currently positive interest rate differential to the US and the government change contributed to this (see “currency models USDJPY”, 10.01.2009). The new government indeed switched the focus from export-oriented industry (such as Toyota; companies would need a yen weaker than USDJPY 90) to domestic demand. In particular, statements by Finance Minister Fujii that he was “in principle against interventions” on the FX markets could have led to speculation on a stronger yen. Later, though, he pointed out that he would not tolerate any “excessive onesided movements“ of the exchange rate, which yields the big question of whether the BoJ will intervene to weaken the yen.
The bank intervened the last time in 2004, as the Ministry of Finance ordered it to do so. In principle, a country can sell an unlimited amount of its own currency to weaken it. However, this should only be done if the exchange rate is misaligned with the economic evolution, due to speculation (for example). Hence, the assessment of a “fair value” (based on economic data such as prices or external trade) is of prime importance. Big departures from this value can be counteracted without a country being accused of a “beggar-thy-neighbor” policy, leading to competitive advantages. Estimating the fair value is a very complex task, though. In the “currency models”, we find a short- to medium-term value of about USDJPY 90. IMF member Kato said recently that the current exchange rate “reflects the economy’s medium-term fundamentals in a broad sense.” Thus, while significant strengthening of the yen could be counteracted by the government, moderate strengthening does not seem to be ruled out.

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Published on  Wed, Oct 7 2009, 12:28 GMT