Currencies | Mar 31 2011
– G7 in coordinated action to weaken yen
– US economy showing signs of strength
– Repatriation of yen unlikely to have major impact on forex market
– Expectations are for further US dollar gains against the yen
By Chris Shaw
While the US dollar generally weakened in March, the weakness against the Japanese yen in the aftermath of the earthquake and tsunami was short-lived. As Danske Bank notes, the initial reaction was for the US dollar to fall below 80 yen, from where it has subsequently rallied to above 83 yen.
Helping the rally was coordinated intervention by major central banks, the first such action by G7 central banks in 11 years. Given the effort to weaken the yen is a coordinated one, Danske Bank sees good chance of success.
Another factor suggesting further gains for the greenback against the yen is the likelihood Japanese currency repatriation is expected to be relatively limited. As Danske Bank points out, total insurance payments for the earthquake and tsunami are estimated at only 4-7% of total losses.
With insurance companies holding only around 15% of total securities in foreign assets, this suggests repatriation flows of only around US$1 billion. As well, CIBC World Markets notes unlike after the Kobe earthquake in 1995, Japanese firms now have an increasingly hedged foreign asset exposure.
As a repatriation of funds would require the unwinding of any associated hedge, CIBC sees a limited impact on spot Japanese yen rates. The end of the Japanese financial year on March 31st should also have minimal impact, as there is little evidence of any seasonal strengthening in the yen around the end of financial year.
Also in favour of the US dollar in general is a strengthening US economy. CIBC notes while higher oil prices and a double dip in the housing market are weighing on consumption, US GDP growth in the March quarter should still be at an annualised rate of around 2.8%.
As the second round of quantitative easing ends in coming months CIBC expects US treasuries will be sold off, signaling an investor shift to riskier assets. With Fed comments suggesting more positive developments in the US economy are emerging, CIBC sees the US dollar enjoying a cyclical rebound by the middle of the year.
A final point in support of the US dollar is the fact current data suggests non-commercial investors are at present still long the yen. As Danske notes, further yen position unwinding in the face of the coordinated action by the G7 central banks could be the catalyst needed to push the US dollar higher against the Japanese currency.
CIBC agrees, pointing out while a pick up in restoration and rebuilding will offer a boost to Japanese economic activity, this boost will likely prove only temporary. Underlying economic indicators remain weak, so given a need to support an economic recovery post the quake Bank of Japan policy should remain expansive.
Such a policy approach should put pressure on the yen thanks to interest rate differentials. This leads CIBC to forecast a year-end USD/Yen rate of 89.
