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Sunday December 18, 2005 - 23:47:35 GMT
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FX Briefing

FX Briefing 16 December 2005
• Closing of short-yen positions triggers sharp correction
• Fed removes “accommodative”, but indicates further tightening
• Ifo index climbs to 5-year high

USD-JPY sell-off: all must go!

The forex market was shaken up thoroughly this week with the long scorned yen emerging as the winner. During the course of the week, the Japanese currency gained 3.5% against the dollar to about 116, about the same as at the end of October. The yen improved against the euro as well by just under 2% to around 139. The big moves in USD-JPY and EUR-JPY were mainly due to the closure of short-yen positions (carry trades). For example, on the IMM, the net short position of speculative traders reached almost 72 thousand yen contracts at the beginning of December, the highest recorded for over 20 years. And the more momentum the forex market gained, the more investors felt compelled to reduce their exposure.

But the move had begun in EUR-USD. Prior to the FOMC meeting and as a result of the ZEW Index’s substantial increase, EUR-USD recovered on Monday to just under 1.20, whereas EUR-JPY rose to a new record of 143.60. USDJPY got into difficulties after the Fed decision and the publication of the improved Tankan. Then the unexpectedly poor October US trade balance fuelled the movement even more, so that USD-JPY temporarily dropped three points within one day from 120 to below 117.

However, the rate correction is only partly due to the new data. The US economic situation has not changed much since a week ago, and this also goes for Japan and Europe. The Fed’s decision to change the language of its statement, particularly the description of its monetary policy as accommodative, was not unexpected, nor did it reduce US interest-rate expectations significantly. The market still thinks it highly probable that the fed funds rate rise could stop at 4.75%. Moreover, the Fed has stated that “some further measured policy firming is likely to be needed”, which leaves some scope for further interest rate hikes. November industrial production data indicates continued recovery in the hurricane damaged sectors and robust production growth in other areas. And, given the New York Fed and Philadelphia Fed survey results, things are looking good for December too. Finally, the figures on international securities transactions in the US – unfortunately the most up-to-date ones are for October – show sustained strong foreign inflows, particularly in bonds.

On the Japanese side, the Tankan did show a further improvement in companies’ assessment of the situation and the level of the index is nothing to complain about. But the survey results fell short of the extraordinarily favourable expectations of market participants. So a disappointed reaction would also have been conceivable. After its policy board meeting, the Bank of Japan today was as optimistic as before about the further recovery of the economy. It is expecting the return of positive inflation rates by the end of the year. But it will nevertheless take some time until central bank policy is tightened. One reason for this is that the BoJ wants to be sure that deflation is truly conquered. Another reason might be that it is taking the wishes of the Japanese government into account, which in any case has to put up with a certain dampening of growth because of its plans to consolidate public finances.

In the EMU, the latest data confirms the more favourable impression. After a small setback in November, the ifo business climate index improved in December from 98.2 to 99.6 points, which is the highest it has been since summer 2000. German retailers, which had for a while been sceptical, were considerably more optimistic again, and even the construction sector improved further despite bad weather conditions.

All in all, growth in the industrial countries looks a lot more balanced. The central banks in Europe, especially the ECB, have started tightening their monetary policies and even the Japanese central bank is slowly edging closer to higher interest rates. But the Fed’s interest rate tightening cycle is not completed yet. It remains open when we will actually see a narrowing of the interest rate spread between these currencies, and whether the dollar’s interest rate advantage –which might be diminishing but will still be considerable – could exert enough of a pull to make the US currency attractive. The correction we have seen this week is a warning that carry trades are not safe bets. But once volatility starts to decrease, they might look good again.

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

This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHF-BANK Group") solely for the information of its clients. The information and opinions in this document are based on sources believed to be reliable and acting in good faith, but no representation or warranty, express or implied, is made by any member of the BHF-BANK Group as to their accuracy, completeness or correctness. Opinions and recommendations are given in good faith but without legal responsibility and are subject to change without notice. The information does not constitute advice or personal recommendation, for which the duty of suitability would be owed, but may facilitate your own investment decision. Moreover, you should seek your own advice as to the suitability of an investment matter mentioned herein. Investors are reminded that the price of securities and the income from them can go down as well as up and that the past performance of an investment or a market is not necessarily indicative for future results. This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete, and this document is not, and should not be construed as, an offer to sell or solicitation of any offer to buy the securities mentioned in it. BHF-BANK Group and its officers and employees may have a long or short position or engage in transactions in any of the securities mentioned in this document, or in any related securities. This publication must not be distributed in the United States.
© 2005 BHF-BANK Aktiengesellschaft
All rights reserved. Please mention source when quoting from it.


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