Yen and Bear It

One immediate consequence of all this will be a much stronger Japanese yen.

The Yuan's Ascent

First, let's map the relative courses of the yuan, the yen and the euro since July 2005, when the managed revaluation of the yuan began. And just as a personal comment, I think the Chinese have been foolish and short-sighted in keeping the yuan artificially weak; the historic experience with mercantilist currency policies is clear in that the manipulator suffers.

Comparative Currency Strength After Yuan Peg Loosened

Click here for larger image.

Source: Bloomberg

Please note how the relative gains of the yuan suddenly matched those of the euro beginning on the very day in June when U.S. long-term interest rates hit their high for the past five years; this is marked with a dotted vertical line.

In addition, note how the yen, the fuel for the on-again/off-again yen carry trade last discussed in September, began to rise soon thereafter. It paused after the Bank of Japan rectified its mid-August error in withdrawing liquidity, but shot higher last week with a vengeance. The magenta vertical line here subsequently marks the Aug. 17 date of the Federal Reserve's cut in the discount rate.

The Yen Carry and Japanese Interest Rates

If the yen is rising, we cannot blame it on any Bank of Japan policy changes. Indeed, the Japanese money market curve has steepened since mid-August, with three-month rates remaining low relative to six-month rates, and six-month rates remaining low relative to nine-month rates.

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Howard L. Simons is president of Simons Research, a strategist for Bianco Research, a trading consultant and the author of The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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