Japanese Yen Relinquishes its Top Safe Haven Status to the Dollar

To answer the first question, we saw a faltering in risk appetite through the end of this past week; but it certainly wasn’t a reversal. In fact, the seven-month rise in optimism looks as stable and strong as it ever has. However, the fundamental drag on this speculative run could soon tip the scales. Capital is still finding its way into the market – and there is a lot of sidelined money to be reinvested – but the major of those funds that are still in relatively ‘risk-free’ assets below to those that are skeptical of the rally to this point or need true interest income rather than the promise of capital gains. Since much of the capital that has returned to the speculative space to this point is looking to ride the steady rally; there is significant risk that a modest pull back could trigger a wave of profit taking that develops a new trend. Does that mean this will happen next week? No. However, a catalyst could certainly move up the time-table for such an outcome. The third quarter earnings season in the US holds this kind of influence. So far, the numbers have been hit-or-miss. Non-financials show the real trajectory of growth (and the comparisons to activity just two years back shows how weak conditions truly are); but the banks are what traders are really looking at. Earnings have surprised for Goldman Sachs and Citigroup; but the first owes its income to trading and the second is likely rolling loan losses into the future. Bank of America’s reading was likely the better reflection of the real health of the group. A $1 billion loss was led by significant lending right offs. If write downs are just being pushed backed and loan loss reserves not bolstered, the pain is just being delayed. 

The next question we have to ask is whether the Japanese yen has flipped its response to risk trends. We saw USDJPY rally over the final days of this past week when sentiment stabilized and pulled back somewhat. However the yen has not abandoned its funding currency status. Taking a look beyond current conditions (where the Japanese Libor is at a premium to the United States’), the Japanese rate is likely to be held at near zero for the longest of its peers. What’s more, the availability of funds is no doubt going to be much higher for Japan. A naturally high savings rate, loose monetary policy and deflation are all buffers of cash.

But, in the interim, should we expect regular fundamental event risk take over for price action? Well, considering the direction the yen held over the final two days of last week when the Bank of Japan and Cabinet Office upgraded their economic forecasts, there is a low probability that data will offer too much guidance. Besides, there are few major market movers scheduled for release on the docket. - JK