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The Secret Behind the Soaring Yen – And How High It Could Fly

Jul 1st, 2010
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In the past couple of months, a lot of attention has been placed on the euro. The single currency has fallen hard and fast. But few people are focusing on the strength of the Japanese yen.

The Asian currency has appreciated rapidly over the last eight months against the US dollar. But more importantly, it has strengthened against the euro. From an exchange rate of 140 yen per euro back in the beginning of the year, it has jumped to just 108 yen per euro in the month of June. That’s a 23% advance in a little over seven months.

But it isn’t the Japanese economy that has helped the yen appreciate. In fact, growth in the world’s second-largest economy continues to remain lukewarm, and consumer confidence and consumption are spent. The country has also seen political turmoil in the past few months, after the prime minister was recently forced out of office.

So what is powering the yen higher? In a word, fear.

Investors are worried about a potential double-dip recession and an economic depression, pushing the yen higher against the euro currency. Essentially, there are rising fears that global deficit reduction strategies are likely to choke off nascent recovery. But Japan has already been through the wringer – it has cut all it can cut. By default, it’s ahead of Europe, which came late to the budget-cutting party. So foreign exchange markets are likely to see further appreciation in the Japanese yen.

We’ve seen this type of appreciation in the EURJPY before. During the financial crisis of 2008, the Japanese yen was being exchanged for as high as 170 per euro. During the following nine-month decline, the currency pair lost almost 33%. Fears of an economic and financial doomsday scenario helped to fuel the yen’s rise as investors viewed the yen as a safer bet.

Before the financial crisis, the Japanese yen served as the main funding currency for the popular carry trade. This is where investors bought a higher-yielding currency – like euro – and sold lower-yielding currencies – like the yen. As soon as risk appetites disappeared, so did the advantage of holding this trade. Risk aversion led many investors to close or reverse their positions in EURJPY, making it less and less of a profitable proposition – boosting the yen.

The same can be said about what has taken place over the last couple of months. With European banking concerns and a Greek default hovering over the markets, investors have become more risk averse. The recent fear has helped to boost demand for the safe haven yen once again.

But how likely are we to see a repeat downfall? And how far are we to fall?

With markets spooked, the likelihood for further declines in the EURJPY pair are pretty good. Currency markets can be sensitive in bad times, even more so in worse times. Just the smallest bit of pessimism can trigger a landslide – and the European euro/Japanese yen isn’t immune to this fact. As long as pessimism and risk aversion remain dominant themes in the current market environment, there will be plenty of buyers of Japanese yen against the European euro.

This point is especially important for Japanese exporters. Companies that export goods and products to Europe will likely see their overseas profits disappear due a stronger yen. The losses appear when the euro profits are exchanged into Japanese yen – it will take more euros to create the same amount of yen profit. In this losing situation, Japanese exporters will look to buy yen while selling euro in the market – helping to minimize the losses they will see in their own profits. Activity like this – expected to be widespread throughout the country – will help to support further JPY strength and EUR weakness.

Given the fact that markets also tend to overshoot, yen momentum is likely to continue far above current levels should we see more market fears and concern from here on in.

If you’re hoping to capitalize on the opportunity or trying to hedge a portfolio, there are several options available. In particular, currency ETFs present the best method of participating in the trend for further yen strength. For those bullish the yen, CurrencyShares Japanese Yen Trust is one such method. Available as FXY, the ETF has moved in relative lockstep with the underlying currency rising by almost 5% since the beginning of the year.

There are also some key indicators to help with timing the trade. First, watch the Dow Jones Industrial Average. The index and the yen have a strong inverse correlation – strength in the Dow will be reflected in a weaker Japanese yen, and vice versa. So, should the Dow Jones post a significantly negative day, yen strength is likely to be in the making.

And watch China. Right now, China serves as the symbol of the economic recovery. So any news that may reflect badly on this symbol will help to spark a run to safe havens. That should mean a buying spree in Japanese yen – as risk aversion takes away from euro strength.

Already at 9-year highs, it is very feasible that the EURJPY could test 10-year price targets very soon if the current risk environment persists.

Richard Lee
for The Daily Reckoning

The Secret Behind the Soaring Yen – And How High It Could Fly originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”


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Thoughtless Vandalism Could Also Set This Vehicle Ablaze

Jun 28th, 2010
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At the G20 Summit, US and European politicians were at odds over the best steps forward. Nonetheless, given a weak global economy, government leaders are usually in a hurry to be seen doing something…

Not unlike vandals in Toronto, who — with little regard for the usefulness of their efforts — were arrested by the hundreds. This truck, for example, would benefit from a little less action on opposing sides. 

Thoughtless Vandalism Could Also Set This Vehicle Ablaze originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”


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Russia’s Central Bank Could Boost the Australian and Canadian Dollars

Jun 24th, 2010
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The world’s third-largest foreign exchange reserve is about to become even more diversified.

First Deputy Chairman Alexei Ulyukayev of the Russian central bank said it is looking to move into other currencies in the near term. The biggest beneficiaries are likely to be Australian and Canadian dollars – opening a door for long-term appreciation for both.

Of course, the Russian announcement is hardly surprising, given the market volatility and mounting losses from euro positioning. Europe’s single currency has lost an overwhelming 21% against the US dollar this year alone. And with concerns over Spain’s infrastructure and Greece’s junk status, people are still not too keen on the region’s currency.

Russia in particular has felt the sting. It currently ranks third when it comes to overall foreign exchange reserve holdings. And approximately 41%, or 8 billion, of those holdings remain in euros. So Russia’s move to diversify makes complete sense. But why choose Canada and Australia?

It might seem like a bad move based on the past few months. Both currencies have seen their recent strength sapped. The Australian dollar has sold off a bit against the US dollar, from the 0.9400 high seen earlier this year. Meanwhile, the Canadian dollar has bounced back from parity with the greenback. In April, one Canadian dollar could be exchanged for one US Dollar – but that’s fallen to C.08.

Still, over the long term, that’s earth shattering – in 2000 that same Canadian dollar could only afford 60 US cents. And the forces that pushed the Canadian dollar up so high are still in play – both in Canada and Australia.

Both Australia’s and Canada’s economies are expected to do very well in the coming quarters – with growth rates poised to come in at annualized rates of 4% and 5.5 % respectively. By comparison, expansion in the United States is expected to rise 3% by the end of the year.

Part of the reason for their outstanding growth is their commodity production. While gold production slowed in top producers like the United States and South Africa because of the financial crisis, Australia’s gold market is stronger than ever. It recently became the world’s second-largest gold producer, just behind China. And with the price of gold hitting new highs, Australia’s financial position looks pretty secure.

Canada, on the other hand, is known for its crude oil exports. One of the world’s top 10 oil producers, Canada is a major enabler to America’s addiction to oil. Canadian exporters furnish the United States with approximately 2 million barrels a day. With economic fundamentals positive, expectations for the countries’ currencies remain equally high. Commodity demand will help to prop up both the Australian and Canadian dollars as US fundamentals pale in comparison.

Furthermore, interest rates are expected to rise in both Australia and Canada – while European central bankers may be forced to cut rates even lower. In fact, Canada was already the first G8 nation to raise rates, and Canadian central bank representatives have hinted at further rate increases if growth continues to fan inflation. The Bank of Canada is expected to keep consumer price increases in the range of 2-3%. That rate is currently running at 1.8%.

Comparably, the Reserve Bank of Australia has also raised rates over the last couple of months to help fight inflation. Its inflation rate is expected to top 5% by next year – 2% higher than the maximum pace the country’s central bank allows.

The allure of rising interest rates in both countries will continue to make their currencies attractive to investors. Investors ultimately holding these currencies can reap higher interest rates – through bonds or savings accounts denominated in Australia or Canada.

Obviously Russian policymakers know that and are looking to cash in. And if the euro remains a cellar dweller, more central banks may choose to mimic Russia’s diversification efforts.

There is precedent. Central banks have been known to cut currency holdings if the currency creates losses to the overall reserve. For example, banks took action in 2006 when the US dollar was suffering under a skyrocketing euro. Sweden’s central bank – the Riksbank – cut approximately 40% of their dollar holdings to minimize any further losses to their reserve portfolio. The UAE wasn’t far behind, formally stating their reduction in US dollars soon afterwards. Incidentally, the euro appreciated by another 28% that year, creating gains for both of the central banks’ reserves.

So now the big question is, which central banks are likely to follow Russia’s lead and dump euros in favor of higher yielding currencies like the Australian and Canadian dollars?

Will it be other BRIC members Brazil and India? Both countries have moved up in rank when it comes to economic growth and global clout. Additionally, their reserves have swelled immensely – both nations have now topped the 0 billion mark. Of course, Brazil and India’s euro reserves are not as immense as their European counterparts. But if losses continue to mount on a weaker currency, leaders will surely look to another country’s denomination in order to support stable reserves. This will do nothing but help both commodity currencies make moves higher in the long term.

There is a saying in the markets, “Always go where the big money goes.” And thanks to central banks’ need for reserve diversification, demand is sure to mount for the Aussie and Loonie. As they flood in, other institutions and investors will be more than happy to jump on the bandwagon.

Throw in the fact that foreign exchange markets tend to overshoot quantitative targets, and both currencies may revisit record highs very soon.

Richard Lee
for The Daily Reckoning

Russia’s Central Bank Could Boost the Australian and Canadian Dollars originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”


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Fannie, Freddie Delisting and the Fix Could Cost $1 Trillion

Jun 18th, 2010
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Things aren’t going well for Fannie Mae and Freddie Mac. First, the Federal Housing Finance Agency told them to delist from NYSE, and now, the real price tag of fixing the agencies is coming to light.

In an interview below, Anthony Sanders, a professor of real estate finance at George Mason University, who was called to testify before the House Financial Services Committee, says we should be “very concerned” about Fannie and Freddie, which have become a “huge problem” for a nation with ballooning debt.

How big? Fannie and Freddie guarantee almost trillion in mortgages, and the potential cost of fixing them will be the largest US bailout ever, potentially up to trillion.

Of course, back in March Tim Geithner essentially said he was “on it,” but, according to this interview, nothing’s been done.

The interview came to our attention via The Daily Bail, and here’s a link to the Bloomberg video.

Fannie, Freddie Delisting and the Fix Could Cost Trillion originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”


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Could Gov’t Workers be Fastest-Growing Set of US Millionaires?

Jun 7th, 2010
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This recent Forbes article is of the sort that should be taken with a grain of salt… tales of everyday police officers, firefighters, and teachers becoming millionaires due to lavish public pensions – even in these days of government excess – still sounds a bit unrealistic.

Yet, even with a grain of salty flavoring… there’s probably also a grain of truth. Although many types of defined benefit pensions have themselves been retired in favor of the defined contribution sort, the government still has to service deals struck going back at least a generation. How much will that cost?

According to Forbes:

“By my calculations, government workers make more than twice as much [more than private sector workers]. Government workers are America’s fastest-growing millionaires. Doubt it? Then ask yourself: What is the net present value of an ,000 annual pension payout with additional full health benefits? Working backward, the total NPV would depend on expected returns of a basket of safe investments–blue chip stocks, dividends and U.S. Treasury bonds…

“…Based on this small but unfortunately realistic 4% return, an ,000 annual pension payout implies a rather large pot of money behind it– million, to be precise. That’s a lot. One might guess that a million stash would be in the 95th percentile for the 77 million baby boomers who will soon face retirement.

“That million also happens to be the implied booty of your average California policeman who retires at age 55. Typical cities in California have a police officer’s retirement plan that works as follows: 3% at 50. [...] That does not include health benefits, which might push real retirement compensation close to 0,000 a year.”

This Forbes article provides some useful perspective on pensions. However, critiques of this article have also been thorough. First, Carlsbad, California – the “typical city” referred to — has a cost of living ranked 56 percent above the national average… meaning higher than New York City, for example. Also, police and firefighter benefits there are almost famously high (including the article Forbes cites).

Even with those concerns, when you take into consideration the fact that public employees really can on average earn “30% more than private sector workers,” generous pensions simply add to government largesse. There’s no doubt that among public workers the police, firefighters, and teachers rank among the most essential to the well being of the nation. Those positions are difficult and in many cases dangerous. However, if these employees deserve their wages, well then, compensation still has to be cut back elsewhere in the public sector… so public wages can be brought in line with what the market demands.

You can read more details in coverage from Forbes on the millionaire cop next door.

Best,

Rocky Vega,
The Daily Reckoning

Could Gov’t Workers be Fastest-Growing Set of US Millionaires? originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”


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