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Japan in the spotlight – yen strengthens

Attention has shifted from the Middle East/North African unrest onto Japan for most of this last week. As if having to face an 8.9-magnitude earthquake and a devastating tsunami was not enough, Japan has had to struggle with a massive nuclear alert as well.

The extent of the damage caused by these events has led risk aversion to once again mute any optimism for the global economic situation. The heightening risk aversion made itself visible in the performance of the major equity indices, for the former part of this week.

The Tokyo-based Nikkei was down 6.18 per cent on Monday and down another 10.55 per cent on Tuesday. The extent of the damages and the related radiation risks caused investors to rush out of the riskier assets such as equities.

The same could not be said for the Japanese yen however, which has strangely enough been strengthening despite the unimaginable economic cost of the Japanese situation. As a matter of fact the Japanese yen was in total 10.5 per cent higher against the majors for the former part of this week; it is worth noting that more than half of the mentioned 10.5 per cent increase comes from gains against the AUD and NZD.

If we dissect the flows in order to try to explain the strengthening JPY we easily understand the selling side, where foreign investors will be minimising their exposure to the yen and thus selling it. Also the fact that the BoJ has been injecting trillions of yen into the banking system in an effort to calm markets is also a sell JPY argument. Yet, however, on the buying side, in terms of flows per se, analysts are attributing volumes to repatriation of funds to make good for the extent of the damages so far.

In terms of currencies the Japanese yen holds the role of a funding currency, used to buy higher yielding currencies such as the AUD and the NZD – which process is commonly referred to as carry trade.

When making a carry trade forex investors are effectively selling the Japanese yen to buy other currencies with better yields. Now since these higher yielding currencies are also associated with higher risks, in times of risk aversion when investors will try to minimise their riskier assets, the process of selling the AUD for example to buy back the JPY (which we may call the unwinding of the carry trades) inevitably provides buying support for the JPY.

Japanese authorities soon took remedial action and although in Monday’s policy setting board meeting the BoJ left the policy rate unchanged it doubled the maximum size of the asset purchase facility to 10 trillion yen from the previous 5 trillion yen.

Prior to the earthquake the USD/JPY was mostly trading in the 82 to 83 region but as news of the earthquake hit the wires the currency pair initially spiked towards highs of 83.30, but then continued to dive lower, making current lows of 80.73 at the time of writing.

News that the BoJ was providing banks with more liquidity and speculation it may be intervening on the forex markets did offer temporary support for the USD when seen against the JPY – but it was very short lived. For the current week the USD/JPY has traded in the range of 80.73 – 82.45 so far. For the week we see support in the 81.27 – 80.64 region while the pair should find resistance in the 82.91-83.92 region.

From the eurozone news that euro leaders had found common ground for a deal on a competitiveness pact lent strength to the single currency. The deal covers various aspects including labour markets and debt limits. In addition EU leaders also agreed to increase the EFSF capacity, and to lower the interest and extend the maturity for Greece’s rescue package. The EUR/USD has traded in the range of 1.3855-1.4003 so far this week.

The EUR/USD suffered a correction lower after hitting resistance at 1.4000 Monday and 1.4003 on Tuesday. The pair broke first daily support at 1.3928 but mostly remained contained around the second daily support at 1.3867. For the current week we see resistance in the 1.4042-1.4181 area and support between 1.3758-1.3614 area.

Upcoming FX key events:
Today: SNB rate decision, US Core CPI and Philadelphia Fed business index.
Tomorrow: German Producer Prices, EZ current account, Canadian CPI core.

FX technical key points:
EUR/USD is neutral.
EUR/GBP is neutral.
USD/JPY is bearish target 80.50, key reversal point 82.91.
GBP/USD is neutral.
USD/CHF is bearish, target 0.9117, key reversal point 0.9500.
AUD/USD is neutral.
NZD/USD is neutral.

Please feel free to send any comments or feedback regarding our articles on [email protected].

RTFX Ltd (“RTFX”) is licensed to conduct investment services business by the Malta Financial Services Authority. This information does not constitute an offer or solicitation and is provided for information purposes only.

This information shall not be deemed to constitute advice and should not be relied on as such to enter into a transaction or for any investment decision. Any opinions expressed in this document represent the views of RTFX at the time of preparation.

They are thus subject to change without notice. RTFX believes that the information contained herein is accurate as at the date of publication. However, no warranty of accuracy is given by RTFX and no liability in respect of any errors or omissions, including any third party liability, are accepted by RTFX or any director, officer or employee.

www.rtfx.com

Mr Muscat is senior trader at RTFX Ltd.

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