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Wednesday August 3, 2005 - 20:11:12 GMT
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Forex: Why You Should Buy Yen

Why You Should Buy Yen

I am a believer in the notion that China will allow the yuan to appreciate on a daily basis and over time this pace could quicken (about 0.02% a day in last four days) or slow. I suspect there is enough flexibility in the current system to leave yuan But there is no turning back to say a narrow band around 8.11 as opposed to 8.28 before July21. The world will not stand for it and China has too much to lose to ignore global pressure to move to a float simply to support exports. After all it is China's wage structure not its exchange rate that offers a comparative advantage in labor intensive ventures. And even at a 0.02% average daily pace for yuan appreciation, that is 2% in 100 working days. I suspect too that the 0.02% has a greater risk of accelerating than decelerating or pausing in the next few months as trade tensions with the US (Congress first and foremost and the Bush administration) force more movement up in the yuan. Failure to do so and Schumer and Graham bill will go to a Senate Vote where a veto-proof margin is likely and Treasury will have no choice but to name China an FX manipulator, handing Congress a free pass to pursue protectionist legislation against China. My bet is the yuan is up another 2% by early October.

Officials on the record in Korea and off the record in the US and Europe also want to see the yen appreciate. The notion that the yen should be a weak currency while China pegs the yuan to the dollar or risk being outflanked by Chinese exports no longer is very compelling. Japan's large external surplus and high domestic savings rate also supports a higher currency even if short and long term rates remain well below the rest of the world.

But there are other reasons for liking the yen apart from the lift provided by the appreciating yuan and official desires outside of Japan for broad region-wide currency appreciation.

China as an engine for growth in the region is cranking along at a 9% growth rate...officials appear to have a handle on a soft landing and in this case it looks more like a touch down rather than a landing. Japan's exports to the US are doing well (autos more and electronics less) and they should recover with China ahead. Moreover there is a burgeoning domestic economy - the sleeping giant may have finally awoken. Consumer and firm sentiment indices are by and large turning up. Firms are spending on plant and equipment and firms are hiring more full-time rather than temporary workers. Officials at the rather cautious BoJ are ironically most upbeat (compared with MoF). Governor Fukui today said confidently that inflation should turn positive by end-of-year or early-next...this is critical for ending the zero-rate policy and turning toward a more neutral policy stance (surely to be far more measured than the Fed's measured pace). In the present world of transparent monetary policy, we do not need to see a cut in the daily money market liquidity target first to start accumulating the currency. The yen is going to rally months ahead of actual tightening measures from the BoJ.

Japan's equity market is rallying as well - at 13-month high and bumping up against 12,000, a psychological level...bullish if broken. Real money accounts in recent days are said to have been adding Japanese equities to portfolios. While international equity flows tend to be more currency neutral than say fixed income flows, the stock market rally is not a primary reason for being long yen. Sure Japan is likely to be a net capital exporter ahead as it should given low if rising JGB yields and a current account surplus. But this flow story is more likely to be do equity-inflow-related in the near-term.

Finally the main hang-up for the yen this week is the much awaited vote on postal savings reform bills in Japan's Upper House (slated for Friday but some legislators are trying to have the vote delayed to extend the debate). Koizumi has promised to resign and call an election of the bills are not passed. The vote in the Lower House was razor thin and took lots of finessing by the government to get it through. Well the opposition is said to be even greater in the Upper House and this includes some LDP members (factions). But these statists run the risk of being booted from the LDP if the government falls on a rejection. They could be hung out to dry...not in the "majority" and not in the legislature full stop. What if it is rejected anyway? Buy yen on weakness. I have seen many changes of government in Japan over the years, including a brief stint by the opposition SDP...and asset prices and the yen rarely moved more than momentarily and never by much.

And I must note that one of the more knowledgeable yen masters in the FX market I know on the sell-side has argued convincingly that August is seasonally a very good month for the yen.

Call me hardheaded but I still like euro/yen lower (think start looking for 130 initially) and think stg/yen and chf/yen are also good ways to play it. And dlr/yen (think 101.65 break is growing likelihood in next quarter) and Cad/yen of course.

David Gilmore


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