The forex market has become used to dollar strength against the yen. This year, the yen is the worst performing currency against the dollar among all the highly traded currencies. But there are conflicting opinions as to whether that trend is likely to continue into the second half of the year. The majority of currency analysts call for a push upwards in USD/JPY, but there are some influential voices calling for caution for dollar bulls.
The Non-Farm Payrolls Report came out this morning, and the US economy added 132,000 jobs last month, versus the market prediction of 125,000. Job growth in May was revised upwards from 157,000 to 190,000. Wage growth also picked up, and unemployment remained at the 6-month low of 4.5%. Primarily, this data should signal a rebound in consumer spending, and it confirms the anti-inflationary bias for the Fed. At the very least, growth no longer seems to be a concern, and US interest rates are not likely to go down.
During their meeting last week, the Fed said that the low jobless rate created the potential for inflation. They were expecting a moderate pace of growth, with most economists predicting growth in 2.75% in the second half of this year. Seeing as how today’s NFP Report validates this thinking, the Fed’s hawkish stance on inflation is likely to continue.
And that spells bad news for the yen. Early morning trading today saw the dollar gain the most in three weeks against the yen. While much of this characteristic of overall greenback strength across the board, it also could signal a resumption of the USD/JPY carry trade after some time of profit-taking. The interest rate differential and the differing pace of consumer demand in the two countries reinforce the carry. The yen is also hurt by rising US yields, as treasuries took a beating with ten-year yields going to 5.18%. Also important to note, the ten-year bonds rose faster than the two-year bonds, suggesting an uptick in expectations of inflation.
But dollar bulls are not without significant opposition in the currency market. As first reported by Bloomberg.com, Federal Reserve Bank of San Francisco President Janet Yellen is somewhat dovish on interest rates. She advocates leaving interest rates unchanged for a long time, as that would best encourage growth and discourage inflation. Yellen warns carry traders specifically, arguing that “‘carry trades’…expose investors to ‘substantial exchange-rate risk’ that they may be underestimating.†The low borrowing costs in Japan have created an untenable situation.
Standard Chartered Plc, a London-based bank, does even further in its analysis of a possible carry trade unwind. Currency analysts at the bank argue that volatility in the dollar-yen exchange rate will decline as the interest rate differential closes up. Standard Chartered claims that by the end of the year, US rates will decline 0.25 percentage points to 5.00% and the overnight lending rate in Japan will increase 0.25 percentage points to 0.75%. These two moves, when coupled together, will kill volatility in the currency pair. The final diagnosis is that the dollar will fall to 122 yen by the end of the year.
When the analysis leads to two divergent positions (as we have now), how can we profit? The good news is that most of the disagreement is over the long-term positions of the two currencies. In the short-term, there is a forex market consensus of dollar strength. As Boris Schlossberg of DailyFX.com points out, retail investors in Japan just keeping hopping aboard the carry trade gravy train. We should see the pair test 125.00 soon, and possibly break the resistance on the back of today’s positive data.
Posted: July 6th, 2007 under Carry Trading, Economics, Interest Rates, Japanese Yen, United States Dollar.
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