Will the yen face a repeat of 1995?
After an earthquake in 1995, the yen appreciated quite a bit. But this time may be different.
As Chris told you in Friday’s essay “G-7 Coordinates Intervention to Push the Yen Lower”, the big story was the G7 stepping into the currency market and selling yen on a coordinated basis. As you would expect, it was the worst performing currency of the day by ending up with a loss of about 2.25%. The yen (JPY) fell all the way to 81.99 on Friday morning, but barely climbed back into the 80 handle by the time I left for the weekend on Friday afternoon. All of the excitement in the currency market really took place in the Asian and European trading sessions, so it was actually a fairly quiet day for US traders. In fact, most currencies ended the day higher in US trading, including the yen.
I saw a report from UBS that basically told investors they should forget about yen strength, which certainly backs Chris’s call last week to consider exiting the yen while it’s still relatively high. I’ve had several conversations with investors as to the likelihood that we see a repeat performance after Japan’s 1995 quake when the currency ran up about 20%. I agree with Chris in that it doesn’t seem likely. The world is a much different place now and there are several factors working against a significant appreciation.
First of all, the interest rate environment is different. Back then, we had both the US and Germany cutting interest rates, so the rate differential was narrowing; as opposed to the current situation where interest rates globally are on the rise. In other words, the current interest rate environment was already working against the yen before the quake. Second, one of the few bright spots for Japan was its export strength. It has posted a current account surplus since 1986, so erosion to its trade surplus from increased demand on imports and limitations of some exports would pose a real threat.
We also have a situation where Japan could become the first G7 country to return back into recession after fourth quarter GDP contracted 0.3% as government stimulus was being removed from the economy. Limited economic growth and falling consumer prices before the quake weren’t exactly positive points either. While continued repatriation of funds back into Japan could keep the yen exchange rate sticky for a while, the continued thought of intervention and weaker economic numbers should eventually win out.
Moving west into the United States, its going to be a busy week in the economic data department. Today, we have the existing home sales figures from February. The expected result from a majority of the economists is a drop of 4.7% to an annual pace of 5.11 million. We saw sales of previously owned homes rise to an eight-month high in January, but foreclosures and short sales rising to a 12-month high was the catalyst behind that move. In fact, the foreclosure inventory rose to a record 2.2 million in January, with another 4.7 million households not current on their mortgages.
It’s really a foreclosure and distressed-property driven market, as investors are hand picking real estate that is being thrown in a fire sale by individuals needing to sell, or banks just wanting to unload repossessed inventory. Either way, it’s not exactly a sign of a market returning back to health. While we do have some important numbers to look at this week, such as durable goods and personal consumption, I think most investors are waiting for the final revision of fourth quarter GDP on Friday.
As it sits right now, the expectations call for an expansion of 3% instead of the current revised figure of 2.8%. The original projection for fourth quarter GDP was 3.3%, so it looks like we’ll remain lower than the estimation, but higher than the third quarter number of 2.6%.
As Chris mentioned on Friday, the Swedish krona (SEK) was the best performing currency as it ended the day up by over 2%. There was basically a 3-way tie for second place as New Zealand, (NZD) Australia (AUD), and Norway (NOK) all posted gains of just under 2%. Higher inflation is one of the factors driving rates higher in Sweden, but house prices are also applying some pressure.
Home prices rose 3% in the three-month period through February compared to the same time last year. Prices have risen on an annual basis for 22 consecutive months and caused the central bank to signal that this credit-driven growth may prompt it to pick up the pace of rate hikes as it also deals with the EU’s quickest economic rebound. Chris left me a note to share with you as a few readers had a question regarding the repo rate he had discussed on Friday, so here’s what he had to say:
A repo rate is the discount rate at which a government will agree to repurchase government securities from commercial banks. So these commercial banks can swap their securities at the central bank for cash, increasing liquidity in the markets. If the central bank wants to create more money in the system, they lower the repo rate (sometimes called the discount rate) and more banks bring their securities to the government to swap to cash.
If the government wants to pull in liquidity, it raises the repo rate making it more expensive for banks to swap their treasuries for cash. Repo rates act the same way as the fed funds rate, and is just another tool the central bank can use to adjust liquidity in the markets.
Hopefully that helps to answer some questions.
Both the Australian and New Zealand dollars gained as equities and commodities rose, prompting investors to assume more risk. The winds behind the sails of the Norwegian krone were comments from the central bank that they were less concerned about the krone’s appreciation when evaluating economic policy. In other words, they are giving themselves more scope to raise rates in an attempt to keep housing under control. The central bank, Norges Bank, said the krone is strong but they aren’t especially worried and also said there is a 50% chance of a rate hike in May or June.
Norges Bank has maintained verbiage for a while now that rates were not moving any higher until, at the earliest, mid-year so this change in sentiment fueled more buyers of the krone. It seems that the ECB’s willingness to raise rates in the near term may have been enough to push Norway over to the hawkish side of the fence. Taking into account that a majority of Norwegian exports are petroleum, it looks increasingly likely the economy can withstand higher exchange rates. The fact that interest rates weren’t expected to move as high as previously expected has kept a lid on the krone over the past year, but now that it has been loosened a bit, hopefully it will play some catch up.
Moving over to the euro (EUR), we saw the currency trade well into the 1.41 handle and finished the day up 1%. It seems as though Trichet re-affirmed his plan to raise rates, saying he doesn’t want to change his message on the need to contain inflation. When asked if policymakers still see an imminent rate increase, he said that he had nothing to add nor to withdraw in regard to ECB statements that it may need to raise interest rates in April.
Bets have been increasing that the ECB will push a rate hike out longer as a result of the Japanese earthquake and related events, as Trichet said that the potential impact of the earthquake and aftermath is something we will be thinking deeply about in the coming days. That still doesn’t change policymakers’ concerns over the second round inflation effects, which is where companies increase prices and boost wages to compensate for higher costs that just perpetuates faster inflation. In any instance, euro area inflation rose well above the 2% target to 2.4% last month.
As I came in this morning, most of the currencies are trading higher today except for the yen and Swiss franc (CHF). It seems as though the intervention efforts by the G7 are having the desired effect, at least thus far, as the yen hasn’t seen any sustained appreciation. It doesn’t look like the market wants to challenge the Bank of Japan or the G7 at this point, so look for the yen to hover around current levels with a sell bias until investors have a chance to fully evaluate the situation.
To recap… The markets were digesting the G7 intervention into the yen, but weren’t scared away as the currency rose from its low of the day on Friday. Many aren’t looking for a repeat of 1995 where the yen appreciated quite a bit in the aftermath of that earthquake. It’s a full week in the US data department with the results of existing home sales due out this morning. Rising home prices in Sweden are just another reason for higher rates. Norges Bank expresses more comfort about a stronger currency and higher rates. The ECB remains focused on higher inflation.
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