daily fundamentals

Will a Quarter Point Hike be Good Enough for the Japanese Yen?

Tuesday, 11 July 2006 21:43:53 GMT  |  Kathy Lien, Chief Currency Strategist

• Will a Quarter Point Hike be Good Enough for the Japanese Yen?
• Dollar Sells Off Ahead of Trade Deficit Number
• Euro Rallies on Strong Data and More Reserve Diversification

US Dollar
On a quiet day with no US economic releases on the calendar, the US dollar gave back some of yesterday’s gains ahead of a potentially weaker trade balance report.  The market expects the trade deficit to widen from -$63.4 billion in the month of April to -$65 billion in the month May, which would be the second back to back rise.  Not only have import bills been increasing as a residual of the 25 percent jump in oil prices that we saw in the month of April, but US consumers continue to have an insatiable appetite for foreign goods.  Unless the deficit unexpectedly narrows, tomorrow’s report will bring back concerns about funding insufficiencies as well the US’ structural problems.  In the month of April, net foreign purchases of US securities were only $46.7 billion, far short of the market’s prediction and the same month’s trade deficit.  If the deficit widens again significantly this month, it will be that much more difficult for foreign purchases to meet the mark next week.  However unless we have a sharp surprise the potential impact on the US dollar could be limited as the magnet for volatility is not until next week when we have not only the inflation reports and the report on net foreign purchases due for release, but also Bernanke’s July 19th speech on the economy and monetary policy.  Stephen Roach, the Chief Economist of Morgan Stanley has written an excellent open letter to Ben Bernanke about how to maintain his credibility.  The crux of his 1300 word letter is that Bernanke’s credibility has come to question after having sent mixed messages to market and July 19 is really his chance to “recover” his credibility.  “A third reversal” of the Fed’s stance would be disastrous for the Fed’s as well as his own credibility.  For a Chairman that promised transparency, he has yet to practice it.  Meanwhile, the real action over the past two days has been in Canada.  For the first time since September of 2005, the Bank of Canada did not opt to raise interest rates at their monetary policy meeting and instead chose to leave it unchanged at 4.25 percent this morning.  In addition, they closed the door on any future rate hikes because even though economic growth remains very strong, they expect growth to slow over the next two years as the strong Canadian dollar takes a hit at exports.  Over the past 2 trading days, the Canadian dollar has already fallen 200 pips against the US dollar.

Euro
The Euro has managed to recuperate a part of yesterday’s losses as central bank reserve diversification resurfaces.  Syria is the latest central bank to announce that they will drop their peg to the US dollar by the end of the year and move 50 percent of their reserves into Euros.  Syria only has a small amount of reserves, less than one percent of China’s, but symbolically it is important because it indicates that more countries are looking at the breakdown of their trading activities and realizing that the Eurozone now constitutes a far greater portion of their reserves, which is giving them a good reason to change the mix of their reserve holdings.  As the Eurozone continues to grow, this trend should become even more popular.  In fact it would not be surprising if less than 10 years from now, the Chinese Yuan becomes a rival to the US dollar and Euro as the status of the world’s dominant reserve currency because trade with that country has increased so much for many other countries over the past few years.  Meanwhile the Euro is also seeing a boost from stronger data this morning.  German wholesale prices increased more than expected last month while the French trade deficit narrowed more than expected.  ECB officials continue to be extremely hawkish – Stark said this morning that they will do “everything to guarantee” price stability. 

British Pound
The British pound is also stronger today, but unlike the Euro, it does not have the support of positive economic data.  In fact, the visible trade deficit increased from –GBP5.56 billion to –GBP6.7 billion in the month of May, which was far worse than expected.  Analysts were predicting a narrow trade deficit for the month of May but huge oil imports and falling production pushed the deficit to the second largest ever.  Such a large number suggests that growth and domestic demand may not have been that strong in May which means that there is no reason to expect anything from the Bank of England in the near future. We will get a chance to see more confirmation of this tomorrow when we receive the employment and average earnings report.  A tick up in average earnings would bring back chatter about rising inflation, but the central bank remains non-chalant for the time being. 

Japanese Yen
After two days of strong gains against most of the majors, the Japanese Yen fell across the board today as consumer confidence drops in the month of June from 49.9 to 47.3.  Comments from Japanese government officials suggest that a rate hike Thursday night is not guaranteed.  Finance Minster Tanigaki continued to call for the retention of zero interest rates while Economics Minister Yosano said that the Bank of Japan should consider the market’s expectations when determining monetary policies.  If the Bank of Japan decides to keep their zero interest rate policy, it would certainly be yen bearish because it comes counter to current expectations, but even if they do raise rates by 25bp, it may not be enough to rally the Japanese Yen.  It is very likely that a rate hike could be accompanied by more neutral comments to offset a potential Yen rise, especially since this was what happened when the central bank ended quantitative easing.  They prevented excessive yen strength by saying that an end to QE did not necessarily mean that they would be ending zero interest rates.  This time around, they could just easily say that one rate hike does not necessarily signal more is to come.  At 25bp, the Japanese Yen is still one of the most attractive currencies to short to fund carry trades. 

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