Midday Musings: Dollar Pays for Yen's Annual Fling

Even the mellifluous tones of Federal Reserve Chairman Alan Greenspan, who was more upbeat in today's part two of his semiannual congressional testimony, failed to stem the dollar's recent decline vs. the yen.

The greenback suffered its biggest one-day move vs. the yen since October 1998 on Thursday, hitting its lowest levels since Dec. 14 at 126.40 yen.

Currency traders said those short the yen via direct bets or through so-called carry trades -- in which borrowed yen are reinvested in higher-yielding dollar assets -- were scrambling to cover positions.

The yen's move had dollar bulls scrambling as well.

Ashraf Laidi, chief currency analyst at MG Financial, who last night forecast the dollar would not fall much below 130 yen, noted the "relative calmness" of the dollar's move vs. the euro relative to the yen. At midmorning, the euro had risen to 87.96 cents against the dollar vs. 87.65 late yesterday.

In October 1998, the "collapse" of the dollar vs. the yen was accompanied by more dramatic dollar weakness vs. European currencies, he recalled.

"This supports the notion that rise in the yen is strictly a Japan-driven play rather than a global growth-driven play," Laidi commented via email. "The enforcement of anti-short-selling laws in Japan and the rebound in the Nikkei [which gained another 2.6% Thursday] enhances the yen repatriation play. Japanese companies need every bit of this currency gain as they realize their positions in foreign-owned assets for their end-of-fiscal-year book closings."

In addition, recommendations to increase allocation to Japanese equities this week by strategists at Merrill Lynch, Credit Suisse First Boston, and Deutsche Bank Securities "are a solid catalyst in supporting Japanese equities and the yen, but remain more a reflection of a micro equity call" rather than a wholesale negation of the fundamental appeal of the U.S. and its currency, he wrote.

Due to the dollar's technical breakdown this morning, Laidi forecast the greenback could now decline to as low as 125.28 yen, which would represent a 50% retracement of the dollar's rally from September's lows of 115.75 yen to its recent highs of 135.15 yen. He also noted the yen is approaching its 200-day moving average of 125 for the first time since November.

Still, "the continuously deteriorating state of the Japanese economy will likely increase speculators' appetite to short the Japanese currency once yen repatriation plays are unwound," Laidi predicted.

After Japan's Finance Ministry reported corporate investment shrank 14.5% on a year-over-year basis, Friday's fourth-quarter GDP report is expected to show Japan's economy shrank for a third consecutive quarter, The Wall Street Journal reported today.

U.S. Markets Shrug It Off

As was the case yesterday, the unrest in currency markets appeared to have little impact on U.S. equities. Major averages were mixed at midday and trading in the middle of their intraday ranges. Rather than worrying about the dollar's machinations, equity market participants seemed more concerned that Greenspan's rising optimism is a harbinger of rate hikes.

In reaction to the chairman's comments about a "firming in economic activity" and that "recent evidence increasingly suggests that an economic expansion is already well under way," fed funds futures again were pricing in 50% odds of a tightening at the Fed's May 7 meeting.

Reflecting both weakness in the dollar and the heightened potential for Fed tightening, the Treasury market was being battered. The price of the benchmark 10-year note was recently down 31/32 to 97 21/32, its yield rising to 5.18%.

Once again, the question is how long can the U.S. equity market ignore -- or remain immune to -- weakness in the dollar, if it persists.

"The cause of the strength of the dollar is largely the presumed perception on the part of foreign investors that the rate of return in the U.S. is higher than in their home countries," Greenspan said today, according to wire service reports. He also said the U.S. current account gap could not rise indefinitely, although he's been saying that for years now.

Let's see how the rest of the day pans out and re-examine the link between equities and the dollar in today's offering after the close.