So despite all the cacophony regarding what's going on in Greece at the moment, I just like to focus on Dollar-Yen this week. I think it's quite an interesting setup. Dollar-Yen has briefly traded below 80. But if you look at the options market, the options market is very relaxed. Normally at times like this you would see volatility bid up at the front end of the curve, the market insuring against heavy downside in Dollar-Yen. But that doesn't seem to be the case. So we're going to address the issue whether that's the right move in the market and we should be relaxed about Dollar-Yen or whether one should panic. I've got a chart here showing portfolio flows into Japan. If you remember after the Japanese earthquake there was much focus on whether Japanese insurers would be repatriating international assets to pay local claims in Yen. If we look at this graph that shows net portfolio flows into Japan through the weeks of the year and this goes back like 2005-2006 or so, where we are currently in 2011 there's actually been very large portfolio flows into Japan. So this is a net figure, foreign money coming in less Japanese money going out. So it's strong, the fact that it's strong suggests that the Yen should also be strong because Japan runs a large current account surplus, in theory it should be recycling these trade flows into foreign asset markets. And if we see in a net portfolio flow into Japan it's showing that that isn't the case. But if we actually look at the breakdown of those flows into Japan, it's less Japanese investors repatriating foreign assets and it's actually more foreign investors buying Japanese assets. And the particular point of interest this year has been large Chinese interest in Japanese debt, which we presume is JGB. In fact, in April China bought about $15 billion worth of Japanese debt. Now, we wrote a comment about this and China could say perhaps being a friend in need to Japan offering to buy their debt after the March earthquake supporting Japan in its recovery process, or at the same times it's quite convenient for China because so they want to diversify their Dollar assets and given the size of their Dollar assets, around $3 trillion dollars in global FX reserves or so, the JGB market is one of the few kind of liquid alternatives for the Dollar so it suits them in that regard. And should it depress Dollar-Yen as well and keep the Renminbi soft against the Yen, will that actually support the export market as well? So, I think it's quite a compelling story out there. So the flow story suggests actually the Yen should stay quite strong against the Dollar. And our second chart here just reminds of what's going in the options market. Normally at times when Dollar-Yen is near 80 or under pressure, you would see an inverted curve so that would be the right hand axis. Normally you would see a short term volatility, e.g., one week, bid up substantially over one year volatility. And that's not the case at the moment. The volatility curve is still very steep and very positive. So, has the option market got it right or wrong? I suppose history would suggest that we couldn't really rely on maybe the options market having it right at this stage.
I think it's more likely that with US yield staying so low, 2-year yields just at 0.4, there's very little margin for error with this story. Dollar-Yen could easily sink below 79; could easily drift down to kind of the 76.40 low that we saw briefly in March. I think the chances of coordinated intervention now are very, very low indeed. Back in March this was initially to support Japan in a time of need and address Yen strength. What we're seeing at the moment is a broadly weaker Dollar and I don't think the Fed has any interest in intervening against that or the US Treasury who has a call on intervention has any interest in doing that at the moment. So, I think Dollar-Yen's in quite a vulnerable window and will only turn higher when the US activity story picks up. We think that is something that can happen maybe in two months' time. We've got lower gasoline prices, lower mortgage rates, car sales will probably bounce back; so Dollar-Yen we think in like two or three months' time will be back at 82, maybe a bit higher, but just for the next four weeks or so I think there is this risk that we break down to 76.
Many Thanks
I think it's more likely that with US yield staying so low, 2-year yields just at 0.4, there's very little margin for error with this story. Dollar-Yen could easily sink below 79; could easily drift down to kind of the 76.40 low that we saw briefly in March. I think the chances of coordinated intervention now are very, very low indeed. Back in March this was initially to support Japan in a time of need and address Yen strength. What we're seeing at the moment is a broadly weaker Dollar and I don't think the Fed has any interest in intervening against that or the US Treasury who has a call on intervention has any interest in doing that at the moment. So, I think Dollar-Yen's in quite a vulnerable window and will only turn higher when the US activity story picks up. We think that is something that can happen maybe in two months' time. We've got lower gasoline prices, lower mortgage rates, car sales will probably bounce back; so Dollar-Yen we think in like two or three months' time will be back at 82, maybe a bit higher, but just for the next four weeks or so I think there is this risk that we break down to 76.
Many Thanks
