One of the most surprising developments of the financial crisis and recession has been the continued strength of the Japanese Yen.
The return of relative stability to the world financial system has not prevented the yen from retaining the majority of its crisis induced advances. The Japanese currency has held onto 75% of its gains against the dollar, 65% versus the euro, 60% from the aussie and 75% from the sterling. In comparison the dollar has retained only 47% of its euro gain, 33% of its aussie improvement and 56% of its sterling take.
From its pre-crisis lows late last summer the yen appreciated 21% against the dollar, 34% against the euro, 47% versus the aussie and 53% opposed to the pound. The dollar also improved dramatically, gaining 23% against the euro, 39% versus the Australian Dollar and 32% against the pound.
But the dollar has since given back a substantial portion of its gains keeping only an 11% improvement against the euro, 13% to the aussie and 18% against the pound. The yen however has remained potent. It is still 16% stronger against the dollar, 22% stronger against the euro, 24% versus Australian Dollar and 39% against the pound.
The dollar and the yen were the only major currencies that strengthened during the crisis and that alone gave de facto status to each as a safe haven currency. But as the dislocations in the financial system have lessened so has the safe haven benefit to the dollar. Not so, or not nearly so much, for the yen. Why has the Japanese currency retained more of its crisis enhanced quality?
At the height of the crisis enormous quantities of American investments, primarily Treasuries were purchased by panicked investors. The demand for dollars to buy those US instruments was one of the driving forces behind the greenback’s ascent. But as the acute phase of the crisis has ebbed, the funds placed in the safety of T-Bills, Notes and Bonds have gradually left the United States seeking more remunerative investments elsewhere.
The effect on the dollar has been plain and predictable. Close to half of its crisis gains have been lost. The rationale for the dollar’s rise and fall in response to the financial crisis has been logical, determined by the balance between the need for safety and earning, risk and return.
If the rise in the yen was due to the same influx of safety seeking funds, one explanation for the subsequent stability of the yen could be that the owners of those funds find in Japan a congenial investment environment. Let us look at some of the possibilities.
Perhaps investors expect the Japanese economy to recover earlier than the United States or Europe. Japan is still the second largest economy in the world and its position in Asia and as a supplier to China, the largest industrial country to sustain strong economic growth, could help restore the Japanese economy. But in reality the Japanese economy has been underperforming for more than a 15 years, throughout the economic rise of China. Japanese decline is largely due to internal factors, including expensive and protected consumer and agricultural sectors, bureaucratic and regulatory control of much of the economy, pointless and never ending domestic spending and a stultified political system that inhibited most change.
Then perhaps the victorious Democratic Party of Japan (DPJ) will be able to revive the economy and move the country into the 21st century?
But the policy prescriptions of the DPJ do not give the impression of de-regulatory pro-growth, consumer centered plans for Japan’s economy. Japanese public debt is the highest in the industrialized world at 170% of GDP. Yet the election platform of the DPJ, with its Keynesian emphasis on government spending and its vaguely anti-capitalist and anti-globalization stances seems particularly ill-suited to revive the world’s largest export dependant economy.
When the vagueness of the DPJ economic policies is coupled with the inexperience of their legislators and the opposition of the experienced and entrenched bureaucrats that really run the Japanese economy the promise for reform and restoration becomes even more problematic. It is very hard to discern a positive yen aspect from the DPJ policies themselves or from the movements of the yen in the currency markets over the past several months as the DPJ victory became almost certain.
If the prospects for the Japanese economy have not fortified the yen then perhaps the currency has been supported by its ostensible role as a proxy trade for the Chinese Yuan?
When the financial crisis struck the Beijing Government ended the managed appreciation of the yuan; it has been static against the dollar since last fall. It has been surmised that the yen has played a substitute role to the Chinese currency with traders keeping long positions in the yen as a replacement for the unavailable yuan. And while it is true that the end of yuan appreciation and the advent of yen strength coincide, it is more likely that the proxy currencies for the yuan are the Australian and New Zealand Dollars, which have had strong upward moves largely tied to the success of the Chinese economic stimulus.
If the strong yen is not a harbinger of an economically recovered Japan and if its yuan proxy quality is limited, the remaining reasons behind its supposed safe haven status become even more relevant and interesting.
The idea of the yen as a safe haven currency can be ascribed to two factors. First the likelihood of Japanese default is very low and when tied to Japan’s recent history of deflation Japanese bonds provide the investor with safety of funds and currency stability. That was also the default position of the dollar and its issuer the United States Federal government. Both currencies scored highly in the financial crisis.
The second factor applies only to the yen and might be called the empirical choice. By any measured judgment the yen is an unusual choice for a safe haven currency. Except for the unity of the Japanese political system, most other economic and interest rate factors would seem to be against it. The Japanese economy has performed dismally over the past 15 years and Japan has one of the oldest and most quickly declining populations in the world. Its potential for economic growth seems quite limited.
But the financial crisis played a stronger hand than comparative economics. The worldwide collapse in interest rates destroyed the rationale for the carry trade. The result was a vastly strengthened yen because the attendant trade to the selling of the yen crosses was the panic buying of the yen against the US Dollar. As the carry trade loans came home to Japan and the speculative positions in the yen crosses vanished with the credit lines of the hedge funds the yen was bought extensively but only to close existing positions. In other words once the loans and trade positions were covered there was far less speculative positioning against the yen than would be found in a normal market.
The equation of a stronger yen with financial turmoil was not due to the inherent strength and security of the Japanese economy but to the bubble markets in the carry trade and yen funding. The yen did not rise because traders sought the safety of Japanese investments. The yen rose because the currency markets were overwhelmed by the unwinding of the carry trade and yen funding positions.
But from an empirical view the yen appreciation coincided perfectly with the deepening of the financial crisis. It certainly appeared that the yen was being sought as a safe haven currency. And since the yen had strengthened it was, in fact if not in economic logic, a safe haven currency.
Yen strength, to borrow a phrase, prospered in a fit of absence of mind. The tremendous force of the deleveraging carry trade raised the yen to its current heights. But those forces were one way, buying the yen to close shorts but not opening new long positions.
The yen was not truly a safe haven currency during the financial crisis. With the ending of the crisis the yen has not returned to pre-crisis trading levels. The evidence that there were few safe haven flows into the yen is simple; none have left Japan to weaken the yen.
In the US, a true safe haven during the crisis, the flows that entered during the crisis have now largely left. The dollar was boosted by the flows in and declined as they left. The lack of that second move out of Japan and the yen means that the forces pushing up the yen last fall were not seeking safety in Japanese bonds. The yen was a safe haven only by a trading default of the yen crosses.
Wednesday, September 9, 2009
Tuesday, August 11, 2009
Market Direction
The End of the Dollar Bubble
The reaction of traders to Friday’s Non Farm Payrolls may be the most concrete sign that the currency markets are coming to the end of the financial crisis. The initial response was, as it has been since the unwinding of the security dollar bubble began in March, to sell the dollar against the euro. But the dollar sellers exhausted themselves after barely five minutes and the following dollar surge, though also five minutes, covered twice a much ground. From 8:30 am to 8:35 am euro rose 34 points, from 8:35 am to 8:40 am it dropped 76; good American economic news had finally garnered a positive response from the currency markets.
From last September until March the dominant currency trade was a direct kin to the panic in the financial markets. When in doubt, which was a constant, purchase dollar denominated assets. A huge bubble of Treasury assets were bought with foreign and domestic money. As the crisis rolled on, even though it had started in the US, involved many of the most prominent United States financial institutions, and called forth an unprecedented amount of government intervention and a deluge of dollar liquidity, nothing dented the dollar’s ascendancy. Compared with the potential for the rest of the world the United States was the safest holder of wealth.
The strength of the dollar in this period owed nothing to the traditional standards of economic and currency comparison. Though the amassing of the world’s financial liquidity in United States Treasuries would not typically be thought of as an asset bubble, by any measure of the origin and behavior of asset bubbles it was. Treasury prices were driven higher by unceasing demand which for a time ignored cost and return in a desperate race to secure principal. The psychology of fear is not very different from that of greed in its ability to push markets to excess. Bubbles can form for negative as well as positive reasons.
The dollar asset bubble began to unwind with the bottom of the equity markets in March. If the September to March dollar was the security dollar then we can call the March to June dollar the repatriating dollar.
As financial conditions gradually improved, investors sold Treasuries and placed their funds in commodities, worldwide equities, currencies and other instruments looking for appreciation and return. Because the process did not unfold at once, and because it was largely better conditions in the United States that emboldened investors to assume more risk, it seemed that whenever there were improving economic statistics in the US the dollar would sell off. In fact this was the necessary dollar selling that accompanied the repatriation of foreign-owned dollar assets or American dollar assets transferring to overseas markets and investments. .
Neither the rationale for the security dollar nor the logic for the repatriating dollar could last beyond the original financial and market conditions that produced them. Owners of investment funds will not accept minuscule earnings forever. And despite appearances the amount of funds stashed in Treasuries is not infinite. When the repatriation is complete the pressure on the dollar engendered but not caused by a mending US economy will be removed. We may have finally reached that point.
This does not necessarily mean that the dollar is poised for a strong recovery. The US economy has very serious current and pending problems and the path away from the financial crisis to recovery is unknown; but then again that applies to the rest of the world as well.
The Eurozone and Japan are trailing even the small signs of stability that have arrived in the United States. Still, if the historical performance of the US economy is considered along with the enormous fiscal and monetary stimulus that has been applied to the American economy, the dollar could well outstrip its competitors without the revival of normal economic growth anywhere in the world.
Joseph Trevisani
The reaction of traders to Friday’s Non Farm Payrolls may be the most concrete sign that the currency markets are coming to the end of the financial crisis. The initial response was, as it has been since the unwinding of the security dollar bubble began in March, to sell the dollar against the euro. But the dollar sellers exhausted themselves after barely five minutes and the following dollar surge, though also five minutes, covered twice a much ground. From 8:30 am to 8:35 am euro rose 34 points, from 8:35 am to 8:40 am it dropped 76; good American economic news had finally garnered a positive response from the currency markets.
From last September until March the dominant currency trade was a direct kin to the panic in the financial markets. When in doubt, which was a constant, purchase dollar denominated assets. A huge bubble of Treasury assets were bought with foreign and domestic money. As the crisis rolled on, even though it had started in the US, involved many of the most prominent United States financial institutions, and called forth an unprecedented amount of government intervention and a deluge of dollar liquidity, nothing dented the dollar’s ascendancy. Compared with the potential for the rest of the world the United States was the safest holder of wealth.
The strength of the dollar in this period owed nothing to the traditional standards of economic and currency comparison. Though the amassing of the world’s financial liquidity in United States Treasuries would not typically be thought of as an asset bubble, by any measure of the origin and behavior of asset bubbles it was. Treasury prices were driven higher by unceasing demand which for a time ignored cost and return in a desperate race to secure principal. The psychology of fear is not very different from that of greed in its ability to push markets to excess. Bubbles can form for negative as well as positive reasons.
The dollar asset bubble began to unwind with the bottom of the equity markets in March. If the September to March dollar was the security dollar then we can call the March to June dollar the repatriating dollar.
As financial conditions gradually improved, investors sold Treasuries and placed their funds in commodities, worldwide equities, currencies and other instruments looking for appreciation and return. Because the process did not unfold at once, and because it was largely better conditions in the United States that emboldened investors to assume more risk, it seemed that whenever there were improving economic statistics in the US the dollar would sell off. In fact this was the necessary dollar selling that accompanied the repatriation of foreign-owned dollar assets or American dollar assets transferring to overseas markets and investments. .
Neither the rationale for the security dollar nor the logic for the repatriating dollar could last beyond the original financial and market conditions that produced them. Owners of investment funds will not accept minuscule earnings forever. And despite appearances the amount of funds stashed in Treasuries is not infinite. When the repatriation is complete the pressure on the dollar engendered but not caused by a mending US economy will be removed. We may have finally reached that point.
This does not necessarily mean that the dollar is poised for a strong recovery. The US economy has very serious current and pending problems and the path away from the financial crisis to recovery is unknown; but then again that applies to the rest of the world as well.
The Eurozone and Japan are trailing even the small signs of stability that have arrived in the United States. Still, if the historical performance of the US economy is considered along with the enormous fiscal and monetary stimulus that has been applied to the American economy, the dollar could well outstrip its competitors without the revival of normal economic growth anywhere in the world.
Joseph Trevisani
Tuesday, August 4, 2009
Market Direction
The rise of the Australian and New Zealand Dollars from their March depths to their current levels has been an Asian success story.
Chinese economic growth has cushioned the effects of the worldwide recession in New Zealand and Australia. Both countries export large amounts of raw materials to Asian manufacturing centers, China foremost. The yuan is fixed to the dollar (unofficially) the aussie and kiwi are not. The Australian economy has avoided recession; the New Zealand economy shrank just 1.0% for two successive quarters. As China returns to strong economic growth and the potential for internal unrest diminishes, the two Asian Dollars rise, and everyone in Asia benefits.
China has boosted her GDP growth from 6.1% in the first quarter of 2009 to 7.9% in the second. Beijing’s four trillion yuan ($587 billion) stimulus has produced tangible results. The Shanghai stock exchange is booming, bank loans and credit are flowing to business and consumers, property markets are hot again, and car sales have overtaken those of the United States. The Chinese government, spending money it actually has, is courted by Washington’s debtor politicians who proclaim their belief in a strong dollar and fiscal rectitude lest China Chinese officials withdraw their support for US deficits. The strength of the Chinese economy is imparted to her trading partners and material suppliers Australia and New Zealand, and their currencies rise against the dollar and the moribund American economy.
The additional success of these two commodity currencies is owed largely to the dynamism of the Chinese economy. Without the demand from the mainland, the miners and ranchers of down under would have few places to sell their products. Though the fall in the Antipodean currencies last year had everything to do with the American dollar, the climb back has been, to a large degree, an Asian affair.
From last summer until this past March the Australian and New Zealand currencies had suffered the same precipitous decline against the dollar as did every major currency except the yen. Panic buying of American Dollar assets trumped every financial and economic consideration during the prolonged financial turmoil. For the six months following the collapse of Lehman in September neither the aussie nor the kiwi sustained any appreciable rally.
However, since the recovery in world financial markets that began in March these two currencies have gained more than twice as much against the dollar as the euro. From March 4th to June 3rd the euro improved 14.3% against the US Dollar. In that same period the Australian Dollar gained 31.4% and the New Zealand Dollar 34.1%.
Traders, portfolio managers, investors, fund managers, almost everyone who had sought safety in the States and Treasury investments began in the second quarter to seek higher returns outside the United States and largely outside the industrialized world. A portion of the improvement in all currencies versus the dollar was due to this repositioning of assets to more favorable economic environments.
The most favorable of all the destinations, by performance, fiscal ability and government intention was China. Of the major trading currencies the Australian and New Zealand economies have the closest economic connection to China. If China grows by exports or domestic consumption the benefit to the Australian and New Zealand economies are direct, substantial and evidenced in the comparative performance of the two economies.
Japan also has large interests in the China. But the Japanese economy is a special case due to its dependence on exports and limited domestic consumer consumption. The yen also has unusual contingencies that give it undue resilience, primarily its decade long participation in the carry trade and its collapse last fall. Nevertheless one of the reasons for the continued yen strength is its Chinese relationship.
The Chinese stimulus was announced in November of last year but its success was not apparent until the recent release of the second quarter GDP numbers. But the advantage to the Australian and New Zealand Dollars was already priced in by the beginning of June.
Further improvement in the currencies will hinge on continued Chinese expansion. The quality of the economic growth in China is open to speculation. Some of the markets, particularly equities and housing, have bubble like aspects to their rise. Bank loans and credit expansion have been overwrought. Mere concern that the government might tighten credit was enough to cause a five percent fall in the Shanghai exchange.
If the Chinese economic recovery is solid, if it is not grounded in misplaced credit generation and speculation, then the aussie and kiwi have a stronger immediate future than any other major currencies. If China cannot sustain her current growth then these commodity currencies will quickly fall to earth. Either way the Australian and New Zealand economic futures will be written in Beijing and not Canberra or Wellington.
Joseph Trevisani
Chinese economic growth has cushioned the effects of the worldwide recession in New Zealand and Australia. Both countries export large amounts of raw materials to Asian manufacturing centers, China foremost. The yuan is fixed to the dollar (unofficially) the aussie and kiwi are not. The Australian economy has avoided recession; the New Zealand economy shrank just 1.0% for two successive quarters. As China returns to strong economic growth and the potential for internal unrest diminishes, the two Asian Dollars rise, and everyone in Asia benefits.
China has boosted her GDP growth from 6.1% in the first quarter of 2009 to 7.9% in the second. Beijing’s four trillion yuan ($587 billion) stimulus has produced tangible results. The Shanghai stock exchange is booming, bank loans and credit are flowing to business and consumers, property markets are hot again, and car sales have overtaken those of the United States. The Chinese government, spending money it actually has, is courted by Washington’s debtor politicians who proclaim their belief in a strong dollar and fiscal rectitude lest China Chinese officials withdraw their support for US deficits. The strength of the Chinese economy is imparted to her trading partners and material suppliers Australia and New Zealand, and their currencies rise against the dollar and the moribund American economy.
The additional success of these two commodity currencies is owed largely to the dynamism of the Chinese economy. Without the demand from the mainland, the miners and ranchers of down under would have few places to sell their products. Though the fall in the Antipodean currencies last year had everything to do with the American dollar, the climb back has been, to a large degree, an Asian affair.
From last summer until this past March the Australian and New Zealand currencies had suffered the same precipitous decline against the dollar as did every major currency except the yen. Panic buying of American Dollar assets trumped every financial and economic consideration during the prolonged financial turmoil. For the six months following the collapse of Lehman in September neither the aussie nor the kiwi sustained any appreciable rally.
However, since the recovery in world financial markets that began in March these two currencies have gained more than twice as much against the dollar as the euro. From March 4th to June 3rd the euro improved 14.3% against the US Dollar. In that same period the Australian Dollar gained 31.4% and the New Zealand Dollar 34.1%.
Traders, portfolio managers, investors, fund managers, almost everyone who had sought safety in the States and Treasury investments began in the second quarter to seek higher returns outside the United States and largely outside the industrialized world. A portion of the improvement in all currencies versus the dollar was due to this repositioning of assets to more favorable economic environments.
The most favorable of all the destinations, by performance, fiscal ability and government intention was China. Of the major trading currencies the Australian and New Zealand economies have the closest economic connection to China. If China grows by exports or domestic consumption the benefit to the Australian and New Zealand economies are direct, substantial and evidenced in the comparative performance of the two economies.
Japan also has large interests in the China. But the Japanese economy is a special case due to its dependence on exports and limited domestic consumer consumption. The yen also has unusual contingencies that give it undue resilience, primarily its decade long participation in the carry trade and its collapse last fall. Nevertheless one of the reasons for the continued yen strength is its Chinese relationship.
The Chinese stimulus was announced in November of last year but its success was not apparent until the recent release of the second quarter GDP numbers. But the advantage to the Australian and New Zealand Dollars was already priced in by the beginning of June.
Further improvement in the currencies will hinge on continued Chinese expansion. The quality of the economic growth in China is open to speculation. Some of the markets, particularly equities and housing, have bubble like aspects to their rise. Bank loans and credit expansion have been overwrought. Mere concern that the government might tighten credit was enough to cause a five percent fall in the Shanghai exchange.
If the Chinese economic recovery is solid, if it is not grounded in misplaced credit generation and speculation, then the aussie and kiwi have a stronger immediate future than any other major currencies. If China cannot sustain her current growth then these commodity currencies will quickly fall to earth. Either way the Australian and New Zealand economic futures will be written in Beijing and not Canberra or Wellington.
Joseph Trevisani
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