Beware of Chinese and Japanese Currency Moves
09/28/2010 12:01 am EST
With no US economic data on the calendar yesterday morning, aside from secondary data such as the Chicago Fed National activity index and the Dallas Fed manufacturing index, it was a quiet morning in the foreign exchange market.
The same old stories of sovereign debt worries, Japanese intervention and pressure on China to revalue their currencies continue to dominate trading today. The euro shrugged off Moody's decision to downgrade the un-guaranteed senior debt of Anglo Irish Bank from A3 to Baa3, because despite the concerns by rating agencies, the demand at bond auctions shows that investors are still willing to buy Irish bonds despite the risks.
In Asia, USD/JPY remains weak and the risk of further intervention by the Bank of Japan will increase materially once the currency pair falls below 84, a level that we believe the Ministry of Finance and the Bank of Japan are eyeing closely. Therefore, we warn our readers about holding short USD/JPY positions near that level. With USD/JPY tracking US yields, there is a reasonable chance that it will break 84 and maybe even 83 if the Bank of Japan does not conduct a second round of intervention.
Asian currencies in general have performed well overnight in anticipation of further revaluation by China. On Wednesday, the House Ways and Means Committee will vote on the currency bill that would allow the Commerce Department to impose duties on Chinese imports to offset China's undervalued currency. The bill will most likely pass the House but the chance of it passing the Senate before they leave next week for the mid-term elections is slim. Even though the Chinese yuan has appreciated more than 2% to a record high since June, when they pledged to strengthen their currency, there is enough pressure and big events coming up over the next seven weeks for China to publicly revalue their currency once again. Aside from the Currency Bill, G20 Finance Ministers, and Central Bankers will be meeting on October 9-11 and October 22-23 to prepare for the G20 Leaders Summit that is held on November 11-12. Officials from around the world have made it clear that the Chinese yuan will be on the discussion table. The US Treasury is also scheduled to release their semi-annual report on currency manipulation on October 15. Based upon their track record, China usually waits for politically favorable times to make changes to their currency regime because they want to diminish criticism and encourage some back patting at these global events. Remember, saving face is very important to the Chinese and the worst thing that could happen is for President Hu to have to defend China's currency policy against harsh criticism in November.
Will a Second Round of Japanese Intervention be Effective?
Meanwhile, one interesting question that we have been asked is whether a second intervention from the Bank of Japan will have the same impact on the currency market as the first. Judging from the latest price action, the intervention has not been all that successful. Intervention in general usually works for only a short period of time before market forces overshadow official flows, causing the currency to move back towards its pre-intervention levels. Yet, if not for the prospect of more quantitative easing (QE) from the Federal Reserve, Japanese intervention could have kept USD/JPY above 85 for a few more weeks. Unfortunately, more QE from the US central bank is all but certain now, and because of that, a second round of Japanese intervention may not be as effective as the first, just like a second round of QE. USD/JPY will still rise because another intervention means the Japanese government is serious about preventing excessive yen strength. However, if the US central bank follows through with additional QE in November, traders will have little incentive to hold US dollars. Japan is in the same boat as the US, but at least they have a trade surplus to fall back on, which creates a natural demand for Japanese yen. The US, on the other hand, is running a very large trade deficit.
By Kathy Lien, currency analyst, KathyLien.com