Tuesday, May 08, 2007

Bold Imagination

I like bold forecasts. Particularly predictions that employ large quantities of imagination, that look beyond the present to big figures far-departed from prevailing price levels. And yesterday, sober, often-prescient, Canadian stalwart, The BCA (The Bank Credit Analyst) did precisely thus, by predicting that Euro-Yen is enroute to YEN180 per solitary Euro.

They say that despite the impressive 80% apreciation since the bottoming of the Euro in 2000, more is in store. They say:
As we have previously highlighted, the ECB will continue to raise rates, which will underpin the euro heading forward. In sharp contrast, Japanese interest rates will not move higher as the country battles with deflation, and the economic data remains soft. Should the euro eventually break up through its previous high and head towards 1.4500, as expected by our Foreign Exchange Strategy service, and the yen holds relatively steady, the cross could get close to 180.00 and test previous highs set in the early 1990s.

Far be it from me to disagree on a lark. For I do understand that in the game of currency-market "rock-paper-scissors", relative interest rates and the bias of change thereto trumps the theoretically important aspects of trade account balance and current account balance. From this perspective, despite mighty mercantile Japan's persistent trade and current account surpluses over the past two decades, negligible unemployment, proximity to the greatest growth conjurer that the world has EVER seen, and the phenomenal accomplishments of Japanese multinational enterprises in terms of technological and market dominance, the MoF has accomplished "plenty much" through ZIRP and fiscal disabusement: They've deterred anyone and everyone from holding or bidding for YEN, including the vast majority of their own citizenry, who Bloomberg reported today now own more mutual funds with non-Japanese assets than mutual funds withn Japanese assets. This is, from the perspective of bureaucrats, a policy triumph equivalent to bringing down the Soviet Union.

Before one picks up the phone and shorts the YEN for EUR, I would point out two things. First, the demise of the Soviet Union was to some extent accidental, since the Reagan build that ostensibly bankrupted the evil empire was itself based upon flawed intelligence intercepted from the Russkies who were essentially fabricating Russia's own military-industrial infrastructure acquisition and troop-strength facts and figures to their own leadership, something American intelligence didn't consider when embarking upon their own 80s build. Secondly, Euro-Yen has been the bane of large macro traders and carried out many in 1998, and after. Now, they are requited, but short YEN IS crowded both explicitly (by financing carry trades) and implicitly, by the Bloomberg figures of Japanese capital obviously (and copiously) flowing abroad.

BCA things nothing will upset the proverbial apple cart, send the cross to 180. They may be right, but many other things must also go right and smoothly for this bold prediction to come to fruition.


Macro Man said...

For this forecast to come true, two things need to happen. First, Europe has to avoid taking steps to proactively weaken the euro as EUR/JPY continues to march higher. As ECB tightening winds to a close, there will be a commensurate rise in the risk of currency intervention from Europe. I don;t know if it will happen, but the risks will rise.

Secondly, one has to presume that the people who have been buying bajillions of euro over the past few years (Voldemort and pals) continue to pursue a strategy based on carry rather than value. While there is nothing to suggest a switch to value based currency strategies is imminent, obviously the higher the EUR/JPY rate, the higher the expected future return of a value based strategy. It is also worth noting that the euro itself was picked up off the mat in 2002 by value based buyers when it was languishing in the 0.80's against the dollar. Perhaps BCA will be right. But surely there is some level of the yen against the euro at which it makes sense to switch for buy nd hold investors.

I say this as someone who tends to err on the side of short yen positions and has largely avoided the P/L quagmire that has been short EUR/JPY since 2004.

"Cassandra" said...

I cannot imagine the Europeans voluntarily committing economic suicide by permitting prolonged strength of Euro coincidental to increasing trade account deficits, while Japan, with persistent surpluses and weak currency makes hay so to speak. I think they could muster the political will for tight money (as they've historically been inclined) if the fight upon inflation were global. But they will not be heroes in isolation, and now, with Sarkozy who knows not how to hold his tongue, Europe will (on the Jawboning front) be even less inclined to watch their unit of exchange increase while Japanpeople laugh in their proverbial beards.

telecost said...

As I recall it, one of the plausible explanations advanced for the decline of the euro after its inception was that European savers who had previously diversified risk through Francs, Marks, Guilders etc., were disinvesting from the Euro, principally into dollars.
Forex laws were liberalized in Japan about 10 years ago, but at that time J. banks were too preoccupied with their own solvency to be offering customers new savings products. So, it was left to securities companies who couldn't sell stocks after the NASDAQ collapse and 9/11, and whose income-seeking customers had lost capital in the MYCAL collapse to tap into AAA foreign bonds. Banks followed later with foreign currency accounts.
It is said that the proverbial Mrs. Watanabe, the J. household finance comptroller, is one of the biggest players in the yen carry trade. And I see a parallel here with savers actions in the euro-zone and forex liberalization in Japan, albeit with an initially ignored uptake.
Savers diversification in Japan has been on a roll for a couple of years or more now, but it will end some time, and with it yen weakness (assuming no govt. intervention). Based on the European experience, it would seem to have another year or so to run.