The yen has rallied strongly in the last several days. The dollar has lost almost 4% against the Japanese currency, while the euro has lost nearly 4.5% since the start of the week. The main impetus behind the yen's surge appears to be the continued adjustment of hedge ratios by Japanese institutional investors, the belief that foreign demand for Japanese equities is equal to the demand for yen and recommendations by several investment houses to buy yen. Leveraged-fund managers, looking for an easy trend to jump on, have also reportedly entered the fray to buy yen.
Currency speculators have been emboldened by the apparent lack of intervention by Japanese officials and the deafening silence from U.S. officials, who have done little other than repeat the usual cant that a strong dollar is in the interest of the U.S. In the last 24 hours, Japanese officials themselves appear to have egged on the currency speculators. On Tuesday, a senior official warned that businesses should not count on the government to knock the yen back. On Wednesday, a senior official of the ruling
Liberal Democratic Party
warned that officials could not stop the yen's appreciation through "artificial" means, an apparent elliptical reference to the ineffectiveness of intervention.
Also on Wednesday, the market was rife with talk that at a private meeting on Tuesday, former
Ministry of Finance
, also known as Mr. Yen, indicated that as long as Japan's benchmark
Nikkei Stock Average
continues to move higher, Japan could live with the dollar at 110 against the yen. Although the talk has been denied and Sakakibara again cautioned against the premature strengthening of the yen, many market participants are sympathetic to arguments that link the yen's appreciation to the Nikkei's performance.
The Nikkei has rallied for eight consecutive sessions and foreigners are believed to be the featured buyers. This year, foreigners have bought an estimated $48 billion worth of Japanese stocks. In recent months, foreigners have been net sellers of Japanese fixed-income instruments and often in larger size than their equity purchases. The Nikkei moved above 18,000 intraday today, but failed to sustain the strong gains. A near-term pullback to 17,600 to 17,800 seems a reasonable near-term target. After the yen's outsized moves over the last couple of days, this may give short-term speculators an excuse to take some profits on long yen positions.
U.S. asset prices have held up even as the dollar loses ground against the yen, something many observers had argued was unlikely. U.S. equities and bond prices are higher now than when the dollar was trading near 116 yen at the end of last week. The relationship between asset prices and currency movements remains tenuous. The turnover in the foreign-exchange market, something on the magnitude of $1.5 trillion a day, swamps cross-border capital flows by a large factor. Often investors and speculators flip in and out of a currency many times before they liquidate the underlying asset.
The yen's appreciation appears to have more to do with the circulation of capital than with real demand for yen because of a pick-up in economic activity. It is true
gross domestic product
for the January through March quarter was revised slightly higher last week, as was June
. However, Japanese officials and reports from the
Economic Planning Agency
Bank of Japan
, have cautioned that the apparent bounce in the economy was largely a function of government spending and that a self-sustaining recovery is still not at hand. (For more, see a related
story that ran earlier on Wednesday.) Moreover, Japan's
Group of Seven
partners seem to agree. It looks as if the Japanese economy stagnated, if not contracted slightly, in the April through June quarter. Another fiscal stimulus package looks likely and talk has centered on between 5 trillion ($44.69 billion) and 10 trillion yen getting pumped into the market.
With Japan continuing to pursue easy monetary and fiscal policy, economic fundamentals would seem to be a negative for the yen. Yet, the hedging of foreign assets by Japanese institutional investors piggybacked by speculative forces continue to drive the yen higher. As we have all experienced in other markets, sometimes the flows overwhelm reasonable considerations of value. And although I recognize that valuation is especially difficult to get your arms around in the foreign-exchange market, the yen's sharp rise seems to be one of those disjoints between value and price.
Although the dollar's drop against the yen is noteworthy, the proverbial rubber band is stretched even further on the yen-euro cross. The euro's brief history may obscure the significance of the price action. Relative to the old German mark, the yen is trading near levels only seen on three other occasions in the 1990s (July 1993 to August 1993, February 1994 and April 1995 to May 1995). It is here where contrarians with the right anatomy -- strong hearts and stronger stomachs -- can find real value.
Marc Chandler is the chief currency strategist for Mellon Bank. At the time of publication, he held no positions in the currencies or instruments discussed in this column, although holdings can change at any time. While he cannot provide investment advice or recommendations, he invites you to comment on his column at