Yen Seen In Favour As Global Turmoil Recedes

As the turmoil in global financial markets recedes, the yen could well find itself back in favor.

Not only is investor appetite for carry trade unlikely to be as strong it was before the turmoil started, but Japan is likely to come out of the crisis in better shape than its competitors. And - as this coming Monday's Tankan survey from the Bank of Japan is likely to show - a rate hike could now be back on the agenda. "Our economists see upside risks to their forecasts for the Tankan and we think rate (rise) expectations could be revived, should the data surprise to the upside," said Alina Anishchanka, a currency strategist with UBS in London. Hints that the Bank of Japan may already be starting to lean this way were evident in the minutes of last month's board meeting, released Tuesday. Despite the fact that the meeting was held in the midst of a meltdown in global credit markets, the board retained a hawkish tone about the need to keep a tight grip on policy. "The board hinted that they are still eager to make another incremental tightening once credit markets calm," said Greg Gibbs, a senior currency strategist with ABN-Amro in Sydney. Key to this increase in rate expectations is rising evidence that, unlike in the U.K. and the euro zone, the impact of the subprime mortgage crisis on Japanese financial institutions has been minimal. In the minutes, the Bank of Japan said "members agreed that Japanese financial institutions' exposure to credit products including subprime-related ones was not significant and that developments in the corporate bond and commercial paper markets suggested that the accommodative environment for corporate finance was unlikely to change markedly."

BOJ's Tightening Likely

Therefore, with Japan likely to escape the credit crunch impacting on policy elsewhere, the Bank of Japan is in a position to resume tightening rates. As far as the yen itself is concerned, that shouldn't be a problem. Despite the yen's sharp rise in recent months, Japanese exports are holding up well with recent trade data showing the country's surplus surging 287.6% in the year to August, with exports alone climbing 14.5% in that period. Also, with rates headed up, the currency's attraction as a low-yielder to be sold in favor of high yielders as part of a carry trade is likely to diminish. At the same time, market interest in carry trades is likely to wane. Despite a recovery in investor risk appetite to levels last seen at the end of July, before the subprime crisis really exploded, investor interest in relative yields is likely to subside as global economic growth slows. Another important source of support for the Japanese currency could be Japanese investors themselves, as yen-negative flows into overseas assets show signs of drying up. Although end-month interest in higher yields abroad may have helped to push the yen lower midweek, analysts report increasing caution by investment funds in putting money outside Japan. "For the month of September, we believe investment trust outflows have been less than in August and July," said Derek Halpenny, a senior currency economist with Bank of Tokyo-Mitsubishi UFJ, noting that the take up of a recent investment trust launched by retail Japanese investors has declined. Some of this could have to do with the introduction at the end of this month of new regulations curtailing the flow of leveraged investments overseas. On top of this, the appetite of corporate Japan for foreign exchange is also reduced. "The fact that many Japanese importers took advantage of the plunge in dollar/yen in August probably means less is being done as we approach the end of the fiscal half year," Halpenny added. And finally, those who thought the yen might suffer from Yasuo Fukuda's appointment as prime minister this week could also find themselves wrong-footed now that he has reappointed most of former Prime Minister Shinzo Abe's old cabinet. Although some still fear that Fukuda will pursue more expansionist fiscal policies, in an effort to boost the LDP's low standing ahead of elections, other see him as a safe pair of hands. "The inauguration of Fukuda as Japanese prime minister was supportive of the yen, given his pacifist stance and hence stabilizing role on the world stage," said Hans Redeker, head of global foreign exchange at BNP Paribas in London. Early Thursday in Europe, end-month adjustments as well as continued decline in risk aversion is helping to push the dollar and high-yielders higher. At 0702 GMT, the dollar had risen to Y115.63 from Y115.53 late Wednesday in New York. The euro was also up at Y163.68 from Y163.18. The euro had risen to $1.4157 from $1.4127.