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Despite months of uninterrupted net foreign inflows into Japanese equities, Japanese investors have been even bigger net buyers this year of foreign bonds, which offer much more attractive yields than are available in the domestic bond market.
Meanwhile, higher energy prices have increased buying demand for dollars from Japanese importers, which is a significant factor in the foreign exchange market at present, says Robert Lynch, senior vice president and head of Group of 10 foreign-exchange strategy at HSBC Bank (USA) in New York. And while Japanese interest rates have been rising, with the yield on the 10-year Japanese government bond climbing to a one-year high of 1.57% in October, the rise has been matched or even exceeded by increases in US interest rates, he notes. This has been particularly true in the case of shorter-term securities, keeping the “carry” well in favor of the dollar, Lynch says. In the yen-carry transaction, investors borrow at low interest rates in the Japanese money market to invest in higher-yielding securities, such as US treasuries and emerging-market debt. |
“Any change in Japanese policy will be very gradual,” says Laidi of MG Financial. “First, the BOJ will withdraw liquidity, and eventually it will resort to raising rates.”
According to Laidi, China will revalue the yuan again by the end of this year, which will help in capping the dollar’s rise. China revalued the yuan by 2.1% against the dollar on July 21. The US Treasury delayed its semi-annual foreign exchange report until early November. The report likely will criticize China for its lack of greater currency flexibility but is not expected to name China as a currency manipulator. In late September China announced the widening of the yuan’s daily trading band against currencies other than the dollar, such as the euro and the yen, from 1.5% to 3%. While the change allows bigger moves in non-dollar currencies on a short-term basis, it does not represent a further revaluation of the yuan. The People’s Bank of China made no change in the tight trading range between the yuan and the dollar. |
Support for the dollar from higher yields remains finely balanced against the structural deterioration evident in the US current account balance, says Bankim Chadha, global head of macro foreign exchange research at Deutsche Bank. The dollar’s rally this year has been a counter-trend move and not a turning point in the longer-term trend toward a weaker dollar, he says. Worries about the widening US current account deficit will come to the fore again before too long, he adds.
“If interest rates tickle your fancy when it comes to currencies, then the near-term outlook for the dollar is quite good,” says David Gilmore, economist and partner at Essex, Connecticut-based Foreign Exchange Analytics. The US economy must slow, however, and the savings rate must rise in order for the trade balance to improve, he says.
Currency Forecasts
Gordon Platt