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Friday October 24, 2008 - 16:26:41 GMT
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Forex Blog- FX Briefing - Yen and dollar surge

FX Briefing 24 October 2008


·        Global equity market slump continues

·        Dollar wins in crisisYen soars on unwinding of carry trades

·        Dependency on EMU and financing problems burden Eastern European currencies


Yen and dollar surge

The dollar and the yen in particular surged this week. The US currency gained almost 6% against the euro to around 1.26, and the yen more than 14% to 116JPY per euro. The pound sterling, the New Zealand dollar and the Australian dollar also plummeted by about 10% against the dollar. On Friday, the Danish central bank raised its key interest rate by 50 basis points to 5.50% to support the exchange rate of the Danish krone against the euro.


Many emerging market currencies, particularly Eastern European currencies, but others too, were even harder hit. The Polish zloty tumbled over 12% against the dollar, the Turkish lira did likewise. The South African rand plunged about 10%, and the Hungarian forint over 8%, despite a 300 bp rise in interest rates. The Brazilian real also took a battering, falling about 11%. The sharp slide is mainly due to international investors unwinding positions in riskier assets. This appears to be supporting the dollar, as for many institutional investors, regardless of whether they are within or without the US dollar currency area, the dollar is their reference currency. What seems rather unconvincing, however, is the argument that the US are taking more decisive action than other countries, particularly the EU. The numerous monetary and fiscal policy initiatives in the US could just as well be regarded as evidence of the immense pressure to act or the extent of the crisis. The election campaign and easy access to budgets of billions of dollars are probably prompting politicians to act too.


The yen seems to be in a special position: on the one hand, the Japanese banks appear to be

somewhat more robust than their competitors in other countries. On the other hand, there is evidence that carry trades are being unwound on a large scale: Japanese investors, who, because of the extremely low interest rates of the yen, have been investing in higher yielding currencies for years, have become nervous in view of the financial crisis and are now getting rid of their foreign currency assets. Furthermore, the yen was also popular with foreigners, from hedge funds to house builders, as a financing currency. In the wake of the financial crisis, however, it has become more difficult and more expensive to (re)finance these positions; furthermore the sharp appreciation of the yen has probably caused significant losses. At any rate, the combination of the Japanese selling foreign currency assets and foreigners closing or hedging yen short positions is pushing up demand for the yen, resulting in particularly sharp exchange rate reactions in the currently rather illiquid forex markets.


As regards the Eastern European emerging markets, several factors are converging: on the one hand, when problems in the industrialized countries in the EU increase, investors are bound to focus on Eastern Europe. Growth in Eastern Europe, the “workbench” of the West, depends to a large extent on demand in the industrialized countries. On the other hand, domestic demand in the Eastern European countries has benefited for years from very favourable financing conditions: the high growth rates, higher yields and firm currencies attracted international investors and also gave banks favourable refinancing conditions. Easy access to financing, often coupled with a property boom, has led to a sharp rise in corporate, private household debt in most countries. In some countries foreign currency loans also play a major role (over 50% of private household debt in Lithuania, Croatia, Hungary, Rumania, and just under 30% in Poland.


Now the boot is on the other foot: the general flight from risk is making itself felt in the emerging markets; more and more institutional and private investors are getting rid of assets. The equity markets, which had previously benefited from strong international interest, have collapsed; the bond markets have been hit by much wider credit spreads and growing mistrust in local currencies. All this, plus the gloomier economic outlook, is having a direct impact on exchange rates. Countries with high current account deficits, which applies to most Eastern European countries, appear to be particularly vulnerable.


In the present environment, it is extremely difficult to forecast how exchange rates will develop. Basically, the following pattern seems to be applying at present: stabilizing tendencies are giving the euro and other currencies some breathing space, while an escalation of the crisis is leading to further unwinding of risky positions and consequently to the appreciation of the yen and the dollar. The crisis has now developed a momentum of its own, making it difficult to stop the economic downward movement. On the other hand, the political measures implemented so far should not be underestimated, even if their full impact is not felt immediately. In the medium term, the bundle of measures including further massive interest rate cuts, financial sector protection and economic stimulus programmes should help to stabilize the global economy.



Stephan Rieke +49 69 718-4114

Economics Department

+49 69 718-3642

[email protected]

Foreign Exchange Trading

[email protected]

Jörg Isselmann

+49 69 718-2695

Matthias Grabbe / Klaus Näfken

+49 69 718-2688


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