Yen weakness - a conundrum

Nick Beecroft, Senior Foreign Exchange Consultant

USD/JPY remains very highly correlated with the short-term yield differential between dollars and yen, and this may explain the yen’s recent slightly puzzling weakness.

With rumours abounding that the Chinese authorities are about to allow some strengthening of the Renminbi, one might have expected the yen to be displaying some sympathetic strength, (on the day of the last ‘step-change’ revaluation of the Renminbi, on 21^st July 2005, the yen appreciated strongly from 112.90 to close at 110.26, although over the next six months it gave back those gains, and more), however, as the expectation of a Chinese move has grown over the last couple of weeks, the yen has weakened against the dollar, from 91.60 to around 94.00.

This despite Greece’s travails and the attendant strains upon the Euro, which might have been expected to promote the usual knee-jerk, safe-haven buying of yen.

Maybe the explanation lies in the market’s suspicions about the outcomes of two key central Bank meetings this week. In the States, the Fed’s FOMC meets on Tuesday and Wednesday, and the Bank of Japan announces the results of its monthly meeting on Friday.

With some slightly more encouraging economic releases in the US, and with Japan still mired in deflation, nervous dollar/ yen shorts are covering their positions in case the FED changes the all important phrase stating that rates are likely to stay, “…exceptionally low…for an extended period” and/or the BOJ is finally persuaded to increase Quantitative Easing measures to combat deflation. 

A double-whammy of such moves would provide a serious boost to dollar/yen, given the market’s focus on the short-term interest differential.

In fact, I expect neither to happen. The FED is increasingly worried that deflation might hit America as the year progresses, as evidenced by the last FED minutes, and the BOJ seems set on its preferred course of complacent inaction until too late.

Or do we underestimate the BOJ? Maybe they’re keeping their powder dry specifically because they want some ammunition at their disposal to combat any yen strength which may follow a Chinese move?