Portugal’s Deficit Higher Than Expected

With three credit rating downgrades in the past week and now news that Portugal’s deficit last year was much higher than expected, speculation has intensified that Portugal will be forced to turn to the European Union for help in meeting its upcoming debt obligations. According to the National Statistics Institute, Portugal’s budget deficit actually totaled 8.6 percent and was considerably more than the government’s target of 7.3 percent.

Source: The Associated Press

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Celtic (Paper) Tiger?

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By Mike Conlon | March 31, 2011

This morning the Euro has rocketed higher despite the fact that Ireland will release the results of its banks’ stress tests, which could show a more dire situation than previously thought. Once considered a shining light on the economic scene, Ireland has been reduced to the poster-child of the global economic bubble.

Yet the market is willing to push that aside as CPI data in the Euro zone came in slightly higher than expected, and traders are pricing in a rate hike at the next policy meeting in early April. Yet the ECB has a difficult task, as entering into a tightening cycle could prove disastrous for both Spain and Portugal who are fighting higher interest rates that are pushing them closer to a bailout.

Meanwhile here in North America, Canada will report GDP figures later this morning and in the US we will have another round of initial jobless claims data which as long as it stays in the 300s, should be seen as positive.

So this morning there is a bit of risk appetite, with commodities higher. Curiously, US stock futures are not higher so perhaps the market is waiting to see the jobless claims. There is still a lot of risk in the markets, so the slightest perception that things aren’t improving could reverse this recent up trend in a heartbeat.

In the forex market:

Aussie (AUD): The Aussie is mostly higher, reaching a new all-time high vs. USD at 1.036 earlier this morning. Retail sales figures came in slightly better than expected, though building approvals came worse than expected. A monthly gain was expected for building approvals which came in negative.

Kiwi (NZD): The Kiwi is also higher despite negative business confidence figures, though this is to be expected after the earthquake they experienced.

Loonie (CAD): The Loonie is showing strength this morning ahead of the GDP report as oil prices have eclipsed 105 again and risk appetite appears to be healthy to start the morning. (Click chart to enlarge)

Euro (EUR): The Euro is the big winner this morning despite the report expected from the Irish bank stress tests. Meanwhile, Portugal has missed its deficit target moving them one step closer to bailout, though German joblessness is the lowest it has been in nearly 20 years. Inflation though accelerated at its fastest pace in nearly 2 years, and the market is fully expecting a rate hike at the next meeting. This could push yields higher on the debt-laden countries, making it harder for them to service their debt. (Click chart to enlarge)

Pound (GBP): The Pound is mostly lower as the UK’s close ties to Ireland put them in a precarious position heading into the bank stress tests.

Dollar (USD): Dollar weakness has been the primary driver of markets of late and the “don’t fight the Fed” mentality has been in full effect. Initial jobless claims are expected to be still in the 300s, though it appears that risk appetite may be waning as the morning progresses. Tomorrow’s NFP will be a major market mover.

Yen (JPY): The Yen is flat to slightly lower, balancing its status as a safe-haven with the weakness inherent from the economic conditions due to the natural disaster.

I’ll keep harping on itâ€"there is still a TON of risk in the markets. I don’t feel that the risk of not gaining interest in the US should out-weigh the potential for another Euro collapse. The debt-stricken countries in the EU have not been provided with relief, and no solution to this crisis has been offered.

The amount of interest these countries have to pay is unsustainable and it is only a matter of time before someone walks away from the table. Germany is still taking a hard-line approach, as internal politics show that the bailouts are unpopular.

Yet they are attempting to force change on some of these regions as pre=conditions for bailout. One such change that they want is for Ireland to raise their corporate tax rate. This is the only thing Ireland has going for them economically so this would be a disaster for their economy.

How this plays out is anyone’s guess, but being Irish myself, I can tell you that they would be more likely to tell Germany to “shove it”, rather than capitulate.

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

To follow these events live with a free, real-time practice account, click here! Don’t miss out on the world’s fastest growing market!

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Forex Volatility Rises from Multi-Year Lows

In the last month, volatility in the forex markets touched both a two-year low and a one-year high. In the beginning of March, volatility essentially returned to pre-credit crisis levels. One week later, when the earthquake and inception of the nuclear crisis in Japan, volatility surged 40%. While it has since resumed its downward path, investors are still bracing themselves for continued uncertainty.

The carry trade has perhaps born the brunt of the volatility spike. The carry trade depends on interest rate differentials â€" as opposed to currency appreciation â€" to drive profits, and  thus demands stability. When the markets become choppy and exchange rates spike wildly in one direction or another, it makes the carry trade significantly more risky. Hence the paradoxical rise of the Japanese Yen to a record high following a series of crushing disasters, as highly leveraged traders moved to unwind their Yen-short carry trades.

Likewise, high volatility should spur demand for so-called safe haven currencies. If only it were clear what constitutes a safe haven currency. Traditionally, that would send the US Dollar, Swiss Franc, and Japanese Yen upwards. In this case, the Franc has benefited most, followed closely by the Yen. The Dollar spiked against emerging market and high-risk currencies, but hardly budged against its G4 counterparts. Could it be that the Dollar’s multi-year positive correlation with volatility has (temporarily?) abated.

With regard to strategy, currency traders have a handful of choices. If you believe that volatility will continue declining or remain stable, you’re probably going to go long emerging market and high-yielding currencies, and short one of the safe-haven currencies, all of which are quite cheap to borrow. The main risk of such a strategy, of course, is that volatility will once again spike, in which these safe have currencies will rally.

If you think that the ebb and volatility isn’t sustainable, then you’re probably going to bet on the Franc, Dollar, or Yen. As I wrote in an earlier post, I think the Yen could theoretically appreciate in the short-term, but actually remains quite risky over the long-term. Despite the best efforts of the Swiss National Bank, the Franc will probably continue appreciation. Economically and monetarily, it is in an excellent shape. Besides, the fact that the supply of Francs is intrinsically small means that even modest capital inflow often translates into a big jump in its its value. As for the Dollar, it is now the most popular currency to short. It remains a safe choice and a good store of value, but probably won’t deliver the returns that safe-haven strategists have come to expect.

From a practical standpoint, you may also want to consider reducing your leverage. As everyone knows, high leverage increases profits but also magnifies losses. In the current environment of heightened volatility, leverage also magnifies risk. Either way, you may also want to consider hedging your exposure, by trading a basket of currencies and/or through the use of options.

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Jobs Preview!

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By Mike Conlon | March 30, 2011

This morning the ADP employment change figures came out showing a gain of 201K jobs which was slightly lower than the expectation of 208K. This seems to be good enough for the markets to continue to plow higher to start the morning, ahead of Friday’s all-important Non-Farm Payrolls Report.

The weak Dollar story continues to drive markets and the market is willing to suspend its disbelief that anything can derail the move higher. This includes risk.

One potential risk event is the slow but sure deterioration of Euro fundamentals, yet the market’s blind eye to the problems resurfacing only masks what is taking place. S&P joined the downgrade party and lowered ratings on Portuguese debt, though this went largely unnoticed. Also, the Irish bank stress tests could show that the government may need to take control over all banks. Yet the market’s singular focus on the potential for a rate hike shows little appreciation for risk.

Let’s also not forget the Japanese nuclear crisis and the Libyan civil war as potential risk events.

Overnight, Asian equity markets were up big-time, following the lead of yesterday’s US stock market gains. Commodities are mostly flat, after yesterday’s reversal in oil prices. Yen weakness continues.

In the forex market:

Aussie (AUD): The Aussie is mostly higher as the risk appetite appears to be strong to start the US session. Yesterday, the Aussie put in a new all-time high vs. USD. (Click chart to enlarge)

Kiwi (NZD): The Kiwi is also higher across the board catching a lift from the rebound in the MSCI Pacific Equity Index despite a report that showed building permits declined nearly 10%. While this is likely to be the result of the earthquake, expect this number to pick up in the ensuing months.

Loonie (CAD): The Loonie is also higher across the board as oil prices are fairly steady around $105. The Canadian raw materials price index came in higher than expected showing that inflation may be creeping higher.

Euro (EUR): The Euro is mostly lower though not as low as one might expect given the risk specific to the Euro zone. Downgrades, stress tests, and high yields should all be reason for concern, yet in the global currency beauty contest the Euro is slightly more attractive than USD. (Click chart to enlarge)

Pound (GBP): The Pound is mostly higher after the index of services reading came in and showed a gain vs. last month’s decline. In addition, the CBI reported sales figure came in much better than expected, showing signs of life for the UK consumer.

Dollar (USD): The Dollar is mixed, trading lower vs. the commodity bloc but slightly higher against the rest. The ADP jobs figures were good but not great, though expectations were higher. Friday’s NFP will let us know where we really stand in the jobs picture and the reported unemployment rate will be interesting if enough people have dropped out of the workforce to warrant a lower number.

Yen (JPY): the Yen continues to weaken with G-7 support and the correlative effects of higher stock prices. Industrial production figures came in better than expected last month, showing that the Japanese economy may have been improving prior to the earthquake.

This Friday’s NFP number will very important as it will show whether of not the employment picture is starting to show meaningful improvement. Everyone knows that QE2 is going to end soon so if the economy can’t stand on its own two feet then we may be in for major trouble.

The selling that is bound to ensue after the Fed removes the punch bowl could be exacerbated if some of these risk events start to unfold negatively. It seems as though the “wait and see” approach to the global economy leaves too much room for error, and my hope is that we see enough improvement in jobs to support economic growth.

But just remember, hope is not an investment strategy!

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

To follow these events live with a free, real-time practice account, click here! Don’t miss out on the world’s fastest growing market!

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Employment Gains Pave the Way for Interest Rate Increase

Wednesday’s employment report provided further evidence that the U.S. labor market is gaining strength. According to the monthly report published by payroll services firm ADP, another 210,000 jobs were created in March marking the sixth straight month of employment gains after several months of losses. In addition to these gains, when compared to last year, the number of planned layoffs in March fell by 39 percent to 41,428 according to statistics tracked by executive placement service provider Challenger, Gray & Christmas.

If the ADP result is confirmed by the Non-Farm Payroll report scheduled for release this Friday morning, the U.S. economy will have created more than 450,000 jobs since the beginning of the year. In the last two quarters, the number of new positions created will be nearly one million.

Despite the predicted increase in jobs this month, the overall unemployment rate is expected to remain at 8.9 percent for March. This is clearly a vast improvement from the 10.0 percent recorded at the end of the fourth quarter but it is a far cry from the five to six percent unemployment which was the “norm” in the years immediately prior to the recession.

So, with unemployment improving, and the economy seemingly on the rebound, should we expect an interest rate increase in the near future? Probably not based on recent comments from Fed Chair Ben Bernanke.

In his testimony before the Committee on Banking, Housing, and Urban Affairs earlier this month, Bernanke made it clear that until conditions show significant improvement, the Fed will hold the line on interest rates for an “extended period”.

As part of his address, Bernanke identified three criteria that must be met before the Fed will consider hiking rates. First off, Bernanke said there must be a marked improvement on the employment front and most would agree that 8.9% unemployment simply fails to meet this standard.

Next, Bernanke said the Federal Open Market Committee (FOMC) must be convinced that the economy has entered a sustainable period of recovery and the rate of inflation must climb to the point that it threatens to exceed the Fed’s mandated target of 2% annual growth. There is no question that, on most fronts, the economy has made gains this quarter but based on Bernanke’s own requirements, we still fall short of the conditions necessary to force the Fed to raise rates.

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Why the Dollar is Here to Stay

In a recent piece published in the WSJ (“Why the Dollar’s Reign Is Near an End“), Berkley Professor Barry Eichengreen declared that the Dollar will soon cease to be the world’s reserve currency. According to Dr. Eichengreen, within 10 years and for various reasons, the Dollar will become one of many reserve currencies, competing for preference with the Euro, Chinese Yuan, Japanese Yen, and Swiss Franc. While Dr. Eichengreen makes some good points, however, I don’t think most of his arguments stand up to scrutiny.

His thesis can be boiled down into a few premises. First of all, he argues that it is fundamentally illogical that oil should be priced in Dollars, and that countries conducting bilateral trade should settle their accounts using Dollars. Dr. Eichengreen is right that this represents the main underpinning of the Dollar. He is wrong to suggest that it will change anytime soon.

That’s because oil ultimately has to be priced in currency. It’s entirely possible that oil exporting countries will band together and decide to price oil in Euros, instead. However, this would mainly be useful as a political tool (albeit a very potent one!) and would serve no economic or risk management purpose whatsoever. If oil were priced in terms of a basket of currencies (such as IMF Special Drawing Rights), it might make oil prices less volatile, but then would require oil exporters to receive 5 (or more!) currencies for their oil instead of one! Finally, the price of oil can and does adjust relative to what happens in forex markets. When the Dollar declined in 2007, oil prices skyrocketed commensurately in order to compensate exporters.

The same largely applies to bilateral trade. While it makes sense for two countries with stable currencies (such as Korea and Japan, for example) to use one of their currencies as the main unit for trade, the same cannot be said for countries with more volatile currencies. For example, if Argentina and Israel are trading, one country would be inherently dissatisfied if trade were denominated either in Shekels of Pesos. When bills are settled in Dollars, however, it is easy and economical for both countries to simply convert those Dollars into currencies which may have more utility for them. As with oil, it’s possible that some countries will decide that it makes more sense to settle trade in Euros instead of Dollars, but again, I don’t see what purpose this would serve and any such decision would probably be politically motivated.

Second, Dr. Eichengreen points out that changes in technology have made it easy to instantly calculate exchange rates and easily convert currency. While I think this point is well-taken, I think people enjoy having a common base currency, if only for psychological reasons. Ultimately, this point is irrelevant because it has very little bearing on the supply and demand for particular currencies.

Third, he argues that the Euro and Chinese Yuan both represent latent threats to the Dollar’s preeminence. Again, he’s both right and wrong. The Euro already represents a viable alternative to the Dollar. It’s economy is reasonably strong, its monetary policy is sensible, its capital markets are deep and liquid. On the other hand, it’s being held back by perennial fears about the a Euro breakup, and the fact that the sum of 20 separate parts is not the same as the whole. Since the EU doesn’t issue sovereign debt, risk-averse investors will be limited to buying German/French/etc. bonds, which are always going to be more less liquid and more risky than US Treasury Securities. Besides, you can see from the chart below that the US economy has actually been growing faster than the Eurozone for the last 30 years.

As for China, I expounded in a recent post about how unlikely it is that the Yuan will seriously rival the Dollar anytime soon. While China certainly has plenty of cachet and expanding vehicles for investment, its capital markets remain much too primitive and opaque for Central Banks and risk-averse investors. Most importantly, the structure of China’s economy is such that foreign institutions simply don’t have the opportunity to accumulate Yuan in massive quantities. Simply, the supply is too small. In fact, the Asian Development Bank forecasts that the Yuan will constitute a mere 3-12% of international reserves by 2035. That doesn’t sound very threatening.

Dr. Eichengreen’s final point is that the Dollar’s safe haven status has been compromised. First of all, this is old news. The Yen is already a â€" if not the â€" preeminent safe haven currency, thus headlines like “Safe-Haven Yen Gains As Radiation Concern Mounts” that take irony to a whole new level. The same goes for the Swiss Franc. However, any concerns that investors have about the Dollar must necessarily also be projected onto the Yen, Euro, and Pound. All of these currencies face current or looming fiscal crises and slowing economic growth. While investors might diversify into other countries, they’re not going to suddenly dump the Dollar in favor of the Euro.

In short, it makes sense that a currency that represents 80% (out of a total of 200%) of all forex transactions and more than 60% of global reserves but only accounts for 25% of GDP, should experience a decline of some sort of decline in popularity. Over the next 50 years, the Dollar will gradually cede share to other currencies. But 10 Years? Give me a break.

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They’re Buying What?

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By Mike Conlon | March 29, 2011

Just when you think you know what is going on in the marketplace, you get thrown for a loop. Apparently now the market believes that the safest place to be is in US stocks. No matter what the situation or risk in the market, stocks seem to keep climbing higher.

Last night President Obama gave his speech on why the US is involved in Libya and at the end of the day he should be afforded the same leeway as every other president who takes military action.

Oil prices are pulling back some, stocks in Europe and Asia are lower, yet US stock futures are higher to start the morning.

IN the UK, GDP figures came in slightly better than expected, posing a decline of .5% vs. an expectation of a .6% decline, with the YoY number coming in as expected at 1.5%. This isn’t too bad considering that the austerity measures are starting to kick in. Right now, the market is expecting the ECB to raise rates before the BOE does, despite the high inflation in the UK.

US home price figures are due out later this morning, s are US consumer confidence figures. It will be interesting to see whether US stocks can hang on, or if the Dollar turns around and weakens.

In the forex market:

Aussie (AUD): The Aussie is lower this morning after putting in a multi-decade high vs. USD. The Aussie had put in 6 days of gains prior to today’s pullback.

Kiwi (NZD): The Kiwi is lower against all but the Yen as overnight trade balance figures came in lower than expected. However, both imports and exports were higher, showing the potential for economic growth.

Loonie (CAD): The Loonie is higher across the board despite lower oil prices to start the day. With relatively little news out of Canada, this appears to be more of a fundamental play on the perceived strength of the Canadian economy. (Click chart to enlarge)

Euro (EUR): The Euro is mostly lower as Dollar strength is driving the forex market this morning.  While there is an expectation that the ECB will raise rates at the April 9th meeting, they first have to navigate the Irish bank stress-tests.

Pound (GBP): The Pound is also some strength, higher against all but the Dollar as the GDP figure came in slightly better than expected. A call for measured rate hikes from a hawkish BOE policy-maker were countered by a statement from the BOE dove who said he would resign if inflation didn’t come back to normal levels this year.

Dollar (USD): The Dollar is stronger across the board despite higher stocks to start the day. Home price figures and consumer confidence numbers are due out later this morning.

Yen (JPY): The Yen is weaker across the board this morning as no additional news about the nuclear crisis has induced Yen buying. The Yen should be weakening after the G-7 intervention, and last night employment figures came out that showed that the economy was actually improving prior to the earthquake. (Click chart to enlarge)

Sometimes the market doesn’t behave as we would expect it to and that is something that all traders have to deal with. Correlations that we rely on sometimes break down and as the saying goes, “the correlations work great until they don’t.”

So it is important to remember to look at the technicals of each pair individually, as anything can happen. Be married to a certain view can sometimes prove dangerous.

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

To follow these events live with a free, real-time practice account, click here! Don’t miss out on the world’s fastest growing market!

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Interest Rate Speculation Boosts Euro

The euro gained on both the yen and the dollar following comments from European Central Bank member Jozef Makuch noting that it was “highly probable” that the bank will raise interest rates next week.

“The euro is squeezing up as people are concentrating again on the prospect of widening rate spreads,” said Jeremy Stretch, executive director of foreign-exchange strategy at Canadian Imperial Bank of Commerce in London.

Source: Bloomberg

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Why the Dollar is Here to Stay

In a recent piece published in the WSJ (“Why the Dollar’s Reign Is Near an End“), Berkley Professor Barry Eichengreen declared that the Dollar will soon cease to be the world’s reserve currency. According to Dr. Eichengreen, within 10 years and for various reasons, the Dollar will become one of many reserve currencies, competing for preference with the Euro, Chinese Yuan, Japanese Yen, and Swiss Franc. While Dr. Eichengreen makes some good points, however, I don’t think most of his arguments stand up to scrutiny.

His thesis can be boiled down into a few premises. First of all, he argues that it is fundamentally illogical that oil should be priced in Dollars, and that countries conducting bilateral trade should settle their accounts using Dollars. Dr. Eichengreen is right that this represents the main underpinning of the Dollar. He is wrong to suggest that it will change anytime soon.

That’s because oil ultimately has to be priced in currency. It’s entirely possible that oil exporting countries will band together and decide to price oil in Euros, instead. However, this would mainly be useful as a political tool (albeit a very potent one!) and would serve no economic or risk management purpose whatsoever. If oil were priced in terms of a basket of currencies (such as IMF Special Drawing Rights), it might make oil prices less volatile, but then would require oil exporters to receive 5 (or more!) currencies for their oil instead of one! Finally, the price of oil can and does adjust relative to what happens in forex markets. When the Dollar declined in 2007, oil prices skyrocketed commensurately in order to compensate exporters.

The same largely applies to bilateral trade. While it makes sense for two countries with stable currencies (such as Korea and Japan, for example) to use one of their currencies as the main unit for trade, the same cannot be said for countries with more volatile currencies. For example, if Argentina and Israel are trading, one country would be inherently dissatisfied if trade were denominated either in Shekels of Pesos. When bills are settled in Dollars, however, it is easy and economical for both countries to simply convert those Dollars into currencies which may have more utility for them. As with oil, it’s possible that some countries will decide that it makes more sense to settle trade in Euros instead of Dollars, but again, I don’t see what purpose this would serve and any such decision would probably be politically motivated.

Second, Dr. Eichengreen points out that changes in technology have made it easy to instantly calculate exchange rates and easily convert currency. While I think this point is well-taken, I think people enjoy having a common base currency, if only for psychological reasons. Ultimately, this point is irrelevant because it has very little bearing on the supply and demand for particular currencies.

Third, he argues that the Euro and Chinese Yuan both represent latent threats to the Dollar’s preeminence. Again, he’s both right and wrong. The Euro already represents a viable alternative to the Dollar. It’s economy is reasonably strong, its monetary policy is sensible, its capital markets are deep and liquid. On the other hand, it’s being held back by perennial fears about the a Euro breakup, and the fact that the sum of 20 separate parts is not the same as the whole. Since the EU doesn’t issue sovereign debt, risk-averse investors will be limited to buying German/French/etc. bonds, which are always going to be more less liquid and more risky than US Treasury Securities. Besides, you can see from the chart below that the US economy has actually been growing faster than the Eurozone for the last 30 years.

As for China, I expounded in a recent post about how unlikely it is that the Yuan will seriously rival the Dollar anytime soon. While China certainly has plenty of cachet and expanding vehicles for investment, its capital markets remain much too primitive and opaque for Central Banks and risk-averse investors. Most importantly, the structure of China’s economy is such that foreign institutions simply don’t have the opportunity to accumulate Yuan in massive quantities. Simply, the supply is too small. In fact, the Asian Development Bank forecasts that the Yuan will constitute a mere 3-12% of international reserves by 2035. That doesn’t sound very threatening.

Dr. Eichengreen’s final point is that the Dollar’s safe haven status has been compromised. First of all, this is old news. The Yen is already a â€" if not the â€" preeminent safe haven currency, thus headlines like “Safe-Haven Yen Gains As Radiation Concern Mounts” that take irony to a whole new level. The same goes for the Swiss Franc. However, any concerns that investors have about the Dollar must necessarily also be projected onto the Yen, Euro, and Pound. All of these currencies face current or looming fiscal crises and slowing economic growth. While investors might diversify into other countries, they’re not going to suddenly dump the Dollar in favor of the Euro.

In short, it makes sense that a currency that represents 80% (out of a total of 200%) of all forex transactions and more than 60% of global reserves but only accounts for 25% of GDP, should experience a decline of some sort of decline in popularity. Over the next 50 years, the Dollar will gradually cede share to other currencies. But 10 Years? Give me a break.

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European Woes!

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By Mike Conlon | March 25, 2011

Yesterday I wrote that the situation in Europe was starting to come to a head as Portugal rejected austerity measures, forcing their PM to resign. Well the two-day European Summit that was supposed to provide clarity into the process for further bailouts became more complicated.

Germany pushed other leaders to reduce the amount that they put in the pot, rather than offering more. Political pressure within Germany is causing Merkel to take a tough stance, though the unpopular message to the Germans should be that they have been able to prosper because of the PIIGS countries and not despite them. Meanwhile further downgrades of Portugal are likely and if bond yields continue to rise, then a bailout may be inevitable.

There’s not a lot of market-moving news today, but last night Japan reported continued deflation that was largely in-line with expectations. I don’t think the market will trade on Japanese fundamentals at this point, as the nuclear crisis is much bigger news. Speaking of, it is hard to tell what is new or stale news. I awoke this morning to hear that there was a reactor leak, though the market has brushed it off. There was also another earthquake there today as aftershocks continue to persist.

In the US later this morning, we will get personal consumption and revised GDP figures, as well as some Fed speak. They announced that they will be holding press briefing with regard to policy in the near future, which could lead to some market volatility if this turns out to be anything more than a PR stunt.

Markets appear to be taking the risk out there in stride, and stocks are higher to start the morning.

In the forex market:

Aussie (AUD): The Aussie is mostly higher as risk appetite appears to still be strong in the market. While there could be a sell-off later in the day heading into the weekend, the Aussie has been strong as of late. (Click chart to enlarge)

Kiwi (NZD): The Kiwi is also higher across the board, riding the wave of the better than expected GDP report that came out 2 days ago.

Loonie (CAD): The Loonie is mostly lower as oil prices have pulled back from recent highs, yet is still trading around $105.50. It wouldn’t shock me to see it move lower as traders pare back risk going into the weekend.

Euro (EUR): The Euro is lower as the bickering taking place at the EU Summit does not inspire confidence despite the fact that German economic sentiment figures came in better than expected. Without a workable solution to the debt crisis, things could get worse for the Euro in a hurry. (Click chart to enlarge)

Pound (GBP): The Pound continues its downward momentum following the BOE’s inaction regarding rate policy. Perhaps consumers will just stop buying which would reduce demand thereby taking prices lower. Great policy!

Dollar (USD): The Dollar is picking up strength as the morning moves forward as perhaps the market is starting to come around to the idea that indeed there is risk in the market. As bad as the Dollar might be from an investment standpoint, it still is the world’s de facto reserve currency so it should be in demand when the stuff hits the fan.

Yen (JPY): The Yen is weaker against all but the Euro and Pound as CPI data last night showed continued deflation. While this was expected, the bigger story is still the on-going nuclear situation and another aftershock that hit today could exacerbate the crisis.

We are in extraordinary times right now, having emerged from what could have been the second coming of the great depression. But the question is now, how do we move forward? There are many obstacles to growth and prosperity which in turn affects how the populace feels.

When there is uncertainty over how people feel, that sometimes trumps all of the economic formulas that government types rely on. Then the head-scratching ensues, as policy-makers are in disbelief that the people just don’t get it.

So perhaps it is better to get out in front of them and tell them what they SHOULD be feeling. That way the economy improves. Brilliant! At least that’s the Fed plan.

Germany on the other hand, is not doing such a good job in the PR department. Perhaps if someone explained to them that without the PIIGS countries lack of economic production that drags down the value of the Euro, Germany might be back on the DM which could potentially be the strongest currency in the word thereby making German exports too expensive for anyone to buy. Cue the unemployment as factories lay workers off to remain profitable.

In either case, they should be careful what they wish for!

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

To follow these events live with a free, real-time practice account, click here! Don’t miss out on the world’s fastest growing market!

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Brazil Gets “Real” about Intervention

Over the last two years, the Brazilian Real has appreciated a whopping 37% against the US Dollar, second only to the South African Rand. It hasn’t been this strong since prior to the credit crisis, and it is rapidly closing in on a record high. If only Brazilian policymakers hadn’t made it a high priority to prevent that from happening.

The appreciation of the Real is being driven primarily by high interest rates, which in turn, are being driven by inflation. Brazilian prices are now rising at an annualized pace of 6%, which is well above the Bank of Brazil’s comfort zone. As a result, it has already raised rates several times in this cycle, including a 50 basis point hike at the beginning of this month. Its benchmark Selic rate now stands at a stratospheric 11.75%, which is higher than any other currency in the same tier.

Of course, the Bank of Brazil understands the implications of continuing to hike rates. With inflation as high as it is, however, it doesn’t really have much of a choice. Moreover, investors are betting on additional rate hikes, which means even wider interest rate differentials. When you also factor in a surprising lack of volatility surrounding the Real, it will certainly become an even more popular target currency for yield-hungry carry traders.

The government of Brazil, however, is doing everything in its power to repel this kind of speculation, lest it drive up the Real further and threaten the competitiveness of its export sector. In 2010, it tripled the tax rate on foreign investment in fixed income securities, to 6%. It increase scrutiny on local banks that have sought to borrow abroad. The national government has taken to doing more of its borrowing on the international market, and deposited the proceeds directly into its forex reserves, in order to mitigate the impact on the Real. The government is also contemplating punishing short-term investors by establishing a “lock-up” period for foreign capital.

And yet, Brazil finds itself in a quandary. While its trade balance has remained positive, its current account balance is now entrenched in deficit territory. Just like the US, it remaisn dependent on foreign investors to bridge this gap every month. Perennial budget deficits also mean the government can ill afford to alienate lenders. Finally, the government still wishes to attract legitimate foreign direct investment in infrastructure projects and portfolio investment in the stock market.

If Brazil is successful in limiting speculation â€" which is difficult, but not impossible given its determination â€" there is a chance that the Brazilian Real will hold steady. After all, Brazil saves less than it needs to invest, and inflation is high enough that there should be some natural downward pressure on the Real. On the other hand, if volatility remains low and speculators continue to find a way around the new capital controls (tempted by 11.75% short-term deposit rates), it will be difficult for the Central Bank to prevent its rise. It can only sit back, continue to hike rates, and pray that speculators soon lose interest.

Personally, I’m betting that the government of Brazil will achieve some measure of success, at least in the short-term. Of all the emerging-market countries engaged in the currency war, it seems to be the most resolute participant after China. At this point, short of fixing the Real to the Dollar, it has shown that it is willing to do whatever it takes to prevent speculators from winning.

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ECB plans emergency scheme for Irish Banks

THE EUROPEAN Central Bank (ECB) is working on an emergency plan to deepen its support for Ireland’s ailing financial system with a new scheme to provide banks with more than €60 billion in medium-term “liquidity” loans.

The initiative, which is being prepared in anticipation of bank stress results next Thursday, will significantly expand the reach of the ECB’s operations in Ireland.

It comes as the Government prepares to make the case to its euro zone partners for significant new measures to ease the burden on the State from the bank bailout.

Since taking office a little more than a fortnight ago, the Government made public on a number of occasions the fact that it was seeking fresh ECB support for the banks.

The Irish Times

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GBP Falls Following BOE Minutes

The Bank of England’s March minutes showed that policymakers are taking a wait-and-see approach regarding the effect of oil prices on the economy, causing sterling to slump.

The pound dropped 0.7 percent to $1.6246 as of 4:41 p.m. today in London, depreciating against all 16 of its major peers. It yesterday reached $1.6401, the strongest level since Jan. 19, 2010. Sterling slipped 0.2 percent to 86.91 pence per euro, after earlier touching 86.55, the strongest in a week.

Source: Bloomberg

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“Currency Manipulation” Will Continue, Despite G20

© 2004 - 2011 Forex Blog.org. Currency charts © their sources. While we aim to analyze and try to forceast the forex markets, none of what we publish should be taken as personalized investment advice. Forex exchange rates depend on many factors like monetary policy, currency inflation, and geo-political risks that may not be forseen. Forex trading & investing involves a significant risk of loss.

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What Are They Thinking?

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By Mike Conlon | March 23, 2011

It seems like there is a lot of “denial” going on around the globe these days, much to the detriment of those who just want to live their lives. Decisions made by those in power have been getting worse and are starting to negatively affect the very same people they are supposed to protect.

Some “questionable” decisions of late: Bernanke’s QE2 policy, Japan’s initial response to the nuclear damage, Obama’s decision to follow the French into bombing Libya, the BOE decision to maintain interest rates in the face of inflation, the EU non-decision on how to handle the debt crisis. All of these judgments have a serious impact on both economic and societal harmony and so far have done little to improve these situations.

So it makes me wonder who is benefiting? Right now, it is seemingly government itself and not the people they represent. This brings me today’s question of the government vote in Portugal, where they are weighing the decision whether or not to accept extreme austerity measures to avoid an EU bailout. Well in today’s economic climate everyone is seemingly out for themselves, so why should Portugal be any different?

It will be interesting to see what they do, but the market has already punished them by pushing bond yields higher, as if they have already chosen. The economic events of the last two years have proved that there is no longer any morality in finance, and once moral hazard is accepted as the norm, there is no reason to behave responsibly.

Thus there is some risk aversion in the marketplace this morning, with stocks and commodities slightly lower.

In the forex market:

Aussie (AUD): The Aussie is trading pretty flat to lower to start the morning as the relative risk in the market is just slight enough to apply pressure. With no news out of Australia this week, the Aussie’s rate differentials look very attractive.

Kiwi (NZD): GDP figures are due out of NZ later this evening which will likely show a hit to GDP in the short-run as a result of the earthquake, but there is optimism that the rebuilding efforts will add to GDP next year. (Click chart to enlarge)

Loonie (CAD): The Loonie is mixed after yesterday’s dismal retail sales figures. As the US goes, so goes Canada. With oil prices retreating slightly to just under $102, the Loonie is also somewhat lower.

Euro (EUR): Were it not for the Pound, the Euro would be lower across the board. Industrial new orders came in lower than expected and the vote by the Portuguese government over whether to accept aggressive austerity measures to avoid an EU bailout. (Click chart to enlarge)

Pound (GBP): The Pound is lower across the board as the there was no change in policy-maker stance to leave rates unchanged in the face of rising inflation. The UK doesn’t have the benefit that the US does by hiding true inflation by measuring things that no on cares about, so the BOE is likely to come under fire. “Merit in waiting” was the operative phrase used to justify their position.

Dollar (USD): The Dollar is seeing some mild strength this morning on risk aversion, though new home sales due out later this morning could change that sentiment. Despite Bernanke’s flooding the market with cash, greedy banks have been hoarding and the US consumer has finally caught on to the fact that now is not a good time to buy a home. Investors have been buying like there is no tomorrow, so I think the Fed might actually be content to let them experience the inevitable loss when interest rates finally have to rise.

Yen (JPY): Almost near the end of week two for the Japanese crisis, and thankfully there is no new news about nuclear problems. They just came out with a price-tag for the recovery, which is north of $300 billion dollars. Gulp.

Policy decisions by the few that affect the many are dangerous because you never can tell what motivates an individual. Part of the problem is that the majority of these decision-makers are NOT elected officials.

Social engineering, weak political will, ideology, and the need to be liked are all hallmarks of weak leadership, and we are seeing it around the globe time and time again. It is not surprising and quite unfortunate, but by not looking out for the “little guy” some of these governments may be in for a rude awakening.

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

To follow these events live with a free, real-time practice account, click here! Don’t miss out on the world’s fastest growing market!

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Nothing Phases These Markets!

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By Mike Conlon | March 21, 2011

Despite the risks in the global landscape, the markets trudge higher! Almost like a child that doesn’t know better, both stock and commodities markets are higher this morning as apparently the facts that NATO forces are lobbing missiles into Libya and Japan has only 2 out of 5 nuclear reactors under control mean increased risk appetite!

Japanese markets are closed to day for holiday, though there is no celebrating taking place there. The nuclear situation is still very much uncertain, as only 2 out of 5 reactors are under control. The G-7 intervention to help weaken Yen should keep a floor on Yen, though if risk events heat up we could see that tested.

Oil is higher this morning trading above $103, as the conflicts taking place in Libya, Bahrain, Yemen and the possible contagion elsewhere has forced a risk premium on the market.

Some of the economic data to watch this week is UK CPI tomorrow and BOE minutes on Wednesday, which could give some insight into whether or not a rate hike may be forthcoming.

Also, the EU Summit taking place on Thursday and Friday could include some Central Bank rhetoric intended to manipulate the Euro.

New Zealand GDP figures on Wednesday and US GDP figures on Friday round out the week, though this week should be more about risk, even if the markets don’t act that way.

In the forex market:

Aussie (AUD): The Aussie has rebounded with increased carry trading as risk aversion has abated. If Central banks want to sell the Yen, you should too! Park it in something that has a good rate like the Aussie, and sit back and collect the daily interest. (Click chart to enlarge)

Kiwi (NZD): The Kiwi is also trading higher on risk appetite though it is still uncertain what affect the earthquake will have on Wednesday’s GDP report.

Loonie (CAD): The Loonie is higher on risk taking and higher oil prices despite last week’s CPI data that came in showing tame inflation. While it is not likely that rates will be raised soon, the Canadian economy appears to be on solid ground.

Euro (EUR): The Euro is mixed today, as would be the case under “normal” risk taking scenarios. However, the markets have been anything but normal over the recent trading sessions. The EU Summit and the end of the week may give more clarity into potential rate decisions.

Pound (GBP): The Pound is higher across the board as home prices rose for the third straight month ahead of tomorrow’s CPI report which is expected to show 4.2% inflation that is well outside of the BOE target range. Minutes from the BOE meeting will be released on Wednesday, so we will see if there is any commitment to thwart inflation. (Click chart to enlarge)

Dollar (USD): The Dollar is mostly weaker ahead of this morning’s existing home sales figures. This number is important because the housing market is really the fly in the ointment for recovery, moiré so than unemployment because if housing doesn’t stabilize, then banks potentially stand to lose more money if Bernanke decides to hike rates down the road.

Yen (JPY): Today is a holiday in Japan so markets are closed. The entire world is focused on the nuclear situation there which has the potential to spook the global economy if the situation gets worse. In the meantime, rescue and recovery efforts are still underway and Japan has a long road ahead of them. G-7 intervention should help.

Maybe I’m just a big “scaredy-cat” but it seems to me that the market is pretty quick to dismiss risk these days. Missiles going off in Libya, nuclear reactors are potential going to meltdown, contagion of unrest spreading to some other Arab and Middle Eastern countries, and no one seems to care.

Just business as usual here in the US; as long as Bernanke keeps the money flowing, continue to buy stocks and commodities. The Dollar may continue to tank, but as long as stocks are going up the mood at the country clubs around the US will be just peachy.

Little do they know that despite higher stock prices, their dollars are worth less! But that’s why you have me, dear readers, as I am trying to get you to be more cognizant of your money and its value (or lack thereof). By investing in currencies you can add to rising stock portfolios and protect your wealth.

Isn’t it time you found out what the forex market is all about?

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

To follow these events live with a free, real-time practice account, click here! Don’t miss out on the world’s fastest growing market!

?

?

?

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Crude Oil Climbs as UN Imposes No-Fly Zone

Oil prices rose more than two dollars in New York this morning to climb above $103 a barrel as traders fretted over the escalation of violence in Libya. Over the weekend, American and British forces, under the authority of the UN Security Council, struck key strategic targets in Libya in the first steps towards establishing a no-fly zone over the troubled region.

In London, brent crude futures for April delivery rose $1.94 to $115.87 a barrel with most observers believing prices will continue to climb.

“Prices are going to go up when there are explosions in a major oil-producing country,” said Michael Lynch, president of Strategic Energy & Economic Research in Winchester, Massachusetts. “Uncertainty in the Middle East is always bad for oil.”

Libya’s oil production has declined considerably since the start of the violence. At the beginning of the year, typical daily output was estimated at 1.6 million barrels a day but production has fallen to just 400,000 barrels a day since the fighting began. If full sanctions are imposed, production may be halted altogether and according to the International Energy Agency, this could last for “many months”.

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Does Japan’s “Triple Disaster” Threaten the Dollar?

While analysts have been busy dissecting the implications of the natural disasters that ravage(d) Japan for forex markets, the focus has naturally been directed towards the Yen. Given all the rumors about the liquidation of foreign (i.e. Dollar-denominated) assets, it’s also worth examining the potential impact on the Dollar. In a nutshell, Japan’s holdings of US Treasury Securities are extensive, and even a partial unloading could have serious implications for the world’s de facto reserve currency.

As I explained in my previous post, the Yen rose to a record high (against the Dollar) following the earthquake/tsunami/nuclear crisis because of rumors that Japanese insurance companies and other financial institutions would begin repatriating all of their foreign assets in order to pay for rebuilding. (For the record, it’s worth pointing out again that this has yet to take place, and any repatriation is probably related to the approaching fiscal-year end. Thus, the Yen is being propelled by speculation/short squeeze. Period.)

Indeed, Goldman  Sachs has estimated that the rebuilding effort will probably cost around $200 Billion. A significant portion of this will no doubt be covered by the payout of insurance claims. How insurance companies will make their claims is of course, unknown. However, consider that Japanese insurance companies have insisted that they have ample cash reserves. In addition, Japan has what is perhaps the world’s most solid earthquake reinsurance (basically insurance for insurers) program, which means primary insurance companies can basically pass these claims up the chain, perhaps all the way to the government.

As for whether the Bank of Japan will sell some its $900 Billion in Treasury holdings, this, too appears unlikely. First of all, the Bank of Japan is doing everything in its power to soften the upward pressure on the Yen, which would not be consistent with selling any of its Dollar-assets. Second,  the Financial Times has further argued that they will be especially unlikely to sell US Treasury securities, because they would lose money on (US Dollar) currency depreciation. Besides, any assets that are sold now to pay for rebuilding would probably need to be repurchased later in order to restore balance sheet equilibrium.

While I am on the topic, I want to draw attention to a recent Treasury report that documented the overseas holdings of Treasury securities. The major surprise was China, whose holdings were revised upwards to $1.18 Trillion (from $892 Billion), which means it is well-entrenched as the most important creditor to the US. However, this was offset by a 50% drop in the Bank of England’s holdings, caused perhaps by a change from US debt to British debt.

As I have written in the past, it seems unlikely â€" for political, economic, and financial â€" reasons that China will move to pare its Treasury holdings in a significant way. Simply, it has no other viable options for investing the foreign exchange reserves that it is forced to accumulate because of the Yuan-Dollar peg. Other doomsdays have speculated that the crisis in the Middle East will end the “petro-Dollar” phenomenon, whereby oil exporters settle their bills almost exclusively in Dollars and use the proceeds to buy Treasuries. While US influence in the Mid East may indeed wane further as a result of the ongoing political turmoil, I don’t think this will force a change to the PetroDollar phenomenon, which is due as much to unavoidable trade surpluses as it is to settling oil transactions in US Dollars.

There is certainly some concern about what will happen when the Fed wraps up QE2 later this year and stops buying Trreasury securities. Two prominent investment companies (PIMCO and Vanguard) have warned that this will cause bond prices to fall and interest rates on debt to rise rapidly. While this is certainly possible, demand for Treasuries will remain strong for as long as the current risk-averse climate remains in place. In addition, given that the US Treasury is not in danger of defaulting anytime soon, yields reflect expectations for inflation and interest rates more than supply/demand for the bonds themselves. Finally, when the Fed stopped buying mortgage backed securities in 2010, mortgage rates fell, contrary to expectations.

In short, the Dollar might continue to fall against the Yen as speculators cover their short positions, but not because of any fundamental reasons. On an aggregate basis, the never-ending string of crises won’t cause the Dollar to collapse. If anything, it might even bring some risk-averse capital back to the US and re-affirm the Dollar’s status as global reserve currency.

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Nothing Phases These Markets!

« Coordinated Action! | Home

By Mike Conlon | March 21, 2011

Despite the risks in the global landscape, the markets trudge higher! Almost like a child that doesn’t know better, both stock and commodities markets are higher this morning as apparently the facts that NATO forces are lobbing missiles into Libya and Japan has only 2 out of 5 nuclear reactors under control mean increased risk appetite!

Japanese markets are closed to day for holiday, though there is no celebrating taking place there. The nuclear situation is still very much uncertain, as only 2 out of 5 reactors are under control. The G-7 intervention to help weaken Yen should keep a floor on Yen, though if risk events heat up we could see that tested.

Oil is higher this morning trading above $103, as the conflicts taking place in Libya, Bahrain, Yemen and the possible contagion elsewhere has forced a risk premium on the market.

Some of the economic data to watch this week is UK CPI tomorrow and BOE minutes on Wednesday, which could give some insight into whether or not a rate hike may be forthcoming.

Also, the EU Summit taking place on Thursday and Friday could include some Central Bank rhetoric intended to manipulate the Euro.

New Zealand GDP figures on Wednesday and US GDP figures on Friday round out the week, though this week should be more about risk, even if the markets don’t act that way.

In the forex market:

Aussie (AUD): The Aussie has rebounded with increased carry trading as risk aversion has abated. If Central banks want to sell the Yen, you should too! Park it in something that has a good rate like the Aussie, and sit back and collect the daily interest. (Click chart to enlarge)

Kiwi (NZD): The Kiwi is also trading higher on risk appetite though it is still uncertain what affect the earthquake will have on Wednesday’s GDP report.

Loonie (CAD): The Loonie is higher on risk taking and higher oil prices despite last week’s CPI data that came in showing tame inflation. While it is not likely that rates will be raised soon, the Canadian economy appears to be on solid ground.

Euro (EUR): The Euro is mixed today, as would be the case under “normal” risk taking scenarios. However, the markets have been anything but normal over the recent trading sessions. The EU Summit and the end of the week may give more clarity into potential rate decisions.

Pound (GBP): The Pound is higher across the board as home prices rose for the third straight month ahead of tomorrow’s CPI report which is expected to show 4.2% inflation that is well outside of the BOE target range. Minutes from the BOE meeting will be released on Wednesday, so we will see if there is any commitment to thwart inflation. (Click chart to enlarge)

Dollar (USD): The Dollar is mostly weaker ahead of this morning’s existing home sales figures. This number is important because the housing market is really the fly in the ointment for recovery, moiré so than unemployment because if housing doesn’t stabilize, then banks potentially stand to lose more money if Bernanke decides to hike rates down the road.

Yen (JPY): Today is a holiday in Japan so markets are closed. The entire world is focused on the nuclear situation there which has the potential to spook the global economy if the situation gets worse. In the meantime, rescue and recovery efforts are still underway and Japan has a long road ahead of them. G-7 intervention should help.

Maybe I’m just a big “scaredy-cat” but it seems to me that the market is pretty quick to dismiss risk these days. Missiles going off in Libya, nuclear reactors are potential going to meltdown, contagion of unrest spreading to some other Arab and Middle Eastern countries, and no one seems to care.

Just business as usual here in the US; as long as Bernanke keeps the money flowing, continue to buy stocks and commodities. The Dollar may continue to tank, but as long as stocks are going up the mood at the country clubs around the US will be just peachy.

Little do they know that despite higher stock prices, their dollars are worth less! But that’s why you have me, dear readers, as I am trying to get you to be more cognizant of your money and its value (or lack thereof). By investing in currencies you can add to rising stock portfolios and protect your wealth.

Isn’t it time you found out what the forex market is all about?

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

To follow these events live with a free, real-time practice account, click here! Don’t miss out on the world’s fastest growing market!

?

?

?

Tags: account, AUD, Aussie, blog, cad, course, currenc, currencies, currency, currency trading, dollar, dow, economy, EUR, Euro, forex, forextrading, free, fx, fxedu, gbp, Il, jpy, market, Mike Conlon, nzd, practice, ssi, time, USD, Yen

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Crude Oil Climbs as UN Imposes No-Fly Zone

Oil prices rose more than two dollars in New York this morning to climb above $103 a barrel as traders fretted over the escalation of violence in Libya. Over the weekend, American and British forces, under the authority of the UN Security Council, struck key strategic targets in Libya in the first steps towards establishing a no-fly zone over the troubled region.

In London, brent crude futures for April delivery rose $1.94 to $115.87 a barrel with most observers believing prices will continue to climb.

“Prices are going to go up when there are explosions in a major oil-producing country,” said Michael Lynch, president of Strategic Energy & Economic Research in Winchester, Massachusetts. “Uncertainty in the Middle East is always bad for oil.”

Libya’s oil production has declined considerably since the start of the violence. At the beginning of the year, typical daily output was estimated at 1.6 million barrels a day but production has fallen to just 400,000 barrels a day since the fighting began. If full sanctions are imposed, production may be halted altogether and according to the International Energy Agency, this could last for “many months”.

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Wild Ride for the Yen

The last week has witnessed unprecedented volatility in the Japanese Yen. Following the earthquake/tsunami and the inception of a nuclear crisis, the Yen defied all logic (and embarrassingly, my own predictions…mea culpa) by rising to a post-World War II high of 76.36 against the Dollar. Then, as rumors of Central Bank intervention began to circulate, it suddenly shot downwards, before resuming a steady upward path. Who knows what next week will bring?!

It’s unclear exactly what’s driving the Yen. Personally, it seems a no-brainer that the string of natural disasters that ravaged Japan would have caused an outflow of foreign capital and a drop in demand (due to a lack of supply) for Japanese imports. In reality, investors began to fear a wholesale selling of Japanese-owned foreign securities widespread repatriation of Japanese Yen by insurance companies and other financial institutions, in order to raise funds for rebuilding and the payout of insurance claims.

While there is still no evidence that such has actually taken place (in fact, the Japanese stock market collapsed as expected, and overseas markets experienced only modest declines), speculators feared the worse, and moved to unload all of their Yen short positions. As hedge funds and domestic Japanese investors tried to exit their Yen carry trades, it caused the market to panic, and the Dollar to fall off a cliff against the Yen, rising 3% in a matter of minutes! As if it wasn’t immediately obvious, “Asset managers, hedge funds, corporates and private clients were all net buyers of the yen for the first time since October,” which means that what we’re basically witnessing is really just a massive short squeeze.

As a result of the highly unusual circumstances, the G7 Finance Ministers held an emergency meeting. The decided not only to offer moral support to the Bank of Japan, but that all G7 Central Banks (Fed, ECB, Bank of Canada, Bank of England) would jointly act to hold down the Yen. Sure enough, the Fed confirmed yesterday that it intervened in the forex markets (probably by selling Yen) for the first time in a decade! This marks a massive about-face from 2010, when Japan was uniformly criticized by the G7 for entering the currency war. Desperate times call for desperate measures…

The Yen has since resumed its appreciation, which has a few implications. First of all, it shows that speculators are still nervous about carry trades that are funded by Yen and continue to think of Japan as a safe haven. This is especially true of domestic Japanese investors, who are naturally bound to become more conservative in the wake of the recent natural disasters. No one knows for certain the size of the Yen carry trade, but 2010 estimates pegged it around $1 Trillion. (Japanese investors purchased $1.25 Trillion in foreign assets between 2005 and 2010 alone!) If that’s the case, there is still quite a bit more unwinding that can be done. In addition, given that Japan is the world’s largest net creditor [the Bank of Japan owns $900 Billion in US Treasury securities, while Japanese sovereign debt is 95% owned by domestic investors], the phenomenon of risk-aversion would be net positive for the Yen.

Second, it shows that investors are skeptical that the Yen’s appreciation can be contained. And if market forces are determined to push the Yen upwards, they are probably right. Simply, the G7 Central Banks (not including Japan) have very limited Yen holdings, which means there is only so much Yen they can sell.

On the flipside, the Bank of Japan has potentially an unlimited supply of Yen at its disposal. In fact, the BOJ already expanded its money printing / quantitative easing program, by “doubling planned purchases of exchange-traded funds, real estate investment trusts, corporate debt, and Japanese government bonds to 10 trillion yen, and launching a program to supply financial institutions with 30 trillion yen in three- and six-month loans at 0.1 percent interest.” This is on top of the 28 trillion yen ($346 billion) that is had already injected into the financial system. While perennial deflation has afforded the BOJ a wide scope, it must still tread cautiously, lest it add inflation (and stagflation) to the country’s list of problems.

Some analyst point to the Kobe earthquake of 1995 as a basis for Yen bullishness. After a one-month lull, the Yen dramatically surged upward, rising 20% in only two months. That disaster also took place towards the end of the Japanese fiscal year (March 31), and seems to suggest that a proportionate Yen rise should take place this time, too.

On the other hand, the Yen proceeded to drop 50% in the two years following the Kobe earthquake, showing the extent to which investors had gotten ahead of themselves. In other words, while there might be significant repatriation of Yen in the short-term, this will more than be outweighed by the decline in GDP, collapse in production/exports, and destruction of stock market value over the long-term.

Until the nuclear crisis is resolved and estimates of the cost (currently pegged at $100-200 Billion) of reconstruction are finalized, the markets will remain jittery. And we all know that volatility will not help the Yen carry trade. Given the BOJ’s determination to hold down the Yen, and the fact that this crisis will only exacerbate Japan’s fiscal issues and its unending economic decline, I’m personally still long-term bearish on the Yen.

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