Yen Strengthens Further

Short yen positions are being covered, driving currency action.
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The U.S. dollar's mixed performance reflects the fact that right now it is not the fulcrum in the foreign exchange market that it often is.

Rather the continued parting of short yen and, to a lesser extent, short Swiss franc positions is the key development among the major currencies. This helps explain the softer bias in the euro and sterling and the firmer bias of the yen and Swiss franc. For the fifth consecutive session the euro is holding above the previous day's low. The upside appears capped in the $1.3240-60 area. A poor ISM reading in the U.S. today, with what could be the second consecutive monthly print below the 50 boom/bust level could see that ceiling tested. The dollar briefly and narrowly rose through yesterday's high against the yen, but has since reversed and is testing the JPY118.00-JPY118.10 support. A retest on the JPY117.50 spike low on Tuesday appears likely. Note that key technical levels are just below there: the 200-day moving average today comes in near JPY117.45, and JPY117.40 is the 61.8% Fibonacci retracement target of the dollar rally to the JPY1122.20 area in late January and early February from JPY114.40 in early December.

There have been several developments that ought not be obscured by the on-going jitters in the equity markets.

First, some observers linked former Fed chief Greenspan's comments about the U.S. economy to the equity market sell-off. As often happened when he was in office, many seem not to understand what he said. Even though he reportedly spoke in a private session in Tokyo today, he did appear to clarify what he may have been misunderstood to have said earlier in the week. We understood his comments earlier in the week as a mostly academic discussion of the business cycle. A business expansion is like a person. It can die of old age. It need not be murdered by policy makers. The U.S. business cycle is mature and it possibly could turn down by the end of the year, although he acknowledged most economists did not think a recession this year was likely. Today reports suggest that the Maestro said that while a recession was possible, it was not probable. His successor Bernanke was even clearer. The Federal Reserve continues to expect U.S. economic growth to pick up and return toward trend. Nevertheless, the market seems to be insisting that the Federal Reserve is asleep at the switch.

The market has re-priced in a rate cut for the third quarter. Assuming for the sake of the argument that the Fed does cut rates at the Aug. 7 meeting, fair value for the Aug Fed funds futures contract is 94.945 (5.055%). It closed yesterday at 94.935 (5.065%). Although not in agreement with this view, the near-term news stream, including today's economic reports, are unlikely to force the market to rethink the assessment. In fact, looking beyond today and into next week, the ECB will raise rates and the early consensus is for the U.S. to report about a 100,000 rise in February non-farm payrolls on March 9, which is below the three, six and 12 months average job growth of 167,000-179,000).

Japan's Ministry of Finance weekly flow data illustrates another force at work besides speculators unwinding short yen exposure. Japanese investors continue to repatriate funds ahead of the fiscal year end. The roughly $2.75 billion sold last week brings the repatriation flow of recent weeks to $12.5 billion (roughly the equivalent of 110,000 futures contracts at the IMM). Foreign investors, as opposed to speculators, continue to buy yen. In the latest reporting period, they bought about $11.5 billion worth of Japanese securities. Also, the spread between US and Japanese 10-year yields has narrowed to 288 basis points, the narrowest of the year. At the same time, the Japanese yield curve continues to flatten and the 2-year to 10-year curve now is the flattest in three and a half years at about 80-81 basis points.

Marc Chandler has been covering the global capital markets in one fashion or another for nearly 20 years, working at economic consulting firms and global investment banks. Currently, he is the chief foreign exchange strategist at Brown Brothers Harriman. Recently, Chandler was the chief currency strategist for HSBC Bank USA. He is a prolific writer and speaker and appears regularly on CNBC. In addition to being quoted in the financial press, Chandler is often a guest writer for the Financial Times. He also teaches at New York University, where he is an associate professor in the School of Continuing and Professional Studies. While Chandler cannot provide investment advice or recommendations, he appreciates your feedback;

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