I’ve written recently about the strength of the Japanese yen and some of the reasons behind the move that brought JPY to an eight month high vs. the US dollar (USD). Last week, Japan’s Finance Minister Fuji had voiced his opposition to government intervention to slow the strength of the Yen, but this week he may be changing his tune. And all of this comes on the heels of the G-20 meeting which wrapped up last week, where who knows what was actually discussed.
Today, Japan reported that consumer prices fell a record 2.4% as deflation is putting further pressure on an already fragile Japanese economy. Combined with the strengthening Yen, this could be a recipe for disaster which could derail economic recovery. It’s no wonder that ex- Bank of Japan Officials and others are back-pedaling from those statements and trying to talk down the Yen, whose strength could harm Japan’s exports.
So what’s going on with the Yen and what does that mean for other currencies and markets going forward? Well if the current correlations hold up, there could be some interesting times ahead in both the stock and currency markets.
Let’s start with a chart of USD/JPY (click chart to enlarge):
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This falls right in line with the new comments that are coming out of Japan that in fact they may not be as adverse to currency intervention as Bank Minister Fuji had just claimed. If deflationary pressures increase, then the BOJ may be forced to intervene in order to spur exports to foster growth and increase employment.
This could reverse the notion that the US dollar has now become the vehicle of choice for the carry trade and could send USD higher as the appetite for dollars picks up. And should the dollar strengthen, than it’s possible that the stock market will decline, as will commodities.
The stock market has had a nice run from its March lows, so a bit of a pull-back may be welcomed. Add to the mix the fact that there is increased chatter about replacing the US dollar as the world’s reserve currency and this time Bernanke & Co. may have to take action.
Just today, Dallas Federal Reserve President Richard Fisher said that the Fed policy reversal could be swift, although he is not an FOMC voting member. This is yet another vocal attempt to re-assure the other nations to stay the course and that the US is not going to let the dollar completely tank.
So the million dollar question is at what point does the Fed reverse policy? Well, it may not be as far away as some market participants think.
Some nations appear to be exiting the recession with New Zealand and Australia leading the way. The global recovery is dependent upon the United States exiting recession, so any sign that we have stabilized could inspire confidence to act.
So while other Finance Ministers are also concerned with the big picture, they also have to look out for their own interests. This could force the Fed to act before they are truly ready, which could send the Japanese yen much lower.
With the all of the uncertainty out there, the one thing we can be sure of is a rise in market volatility, and look for USD/JPY to rise. Let’s just hope this doesn’t take all of the other markets down with it!
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