Wednesday, September 15, 2010

Overview: Risk aversion lifts gold, yen, and US Treasurys


Global stock markets have been rallying this month.

At the same time, gold prices continue to hit record highs, and Treasury yields have sharply declined. These would indicate that there still is a large segment of the investing public that is deeply concerned about worldwide economic trends.

Then there is the yen, which hit 15 year highs versus the dollar yesterday. Although the strength of the yen has not received much press attention here in the United States, it is of deep concern to Japanese businesses, which are depending on export business.

And so this morning the Japanese government intervened in the currency markets for the first time in six years. The Nikkei turned in a strong performance as a result, rallying more than 2%.

It remains to be seen how much effect on a longer term basis the intervention will have. Most governments have stopped trying to intervene in the currency markets, after wasting considerable resources in the 1990's to try to influence currency levels with little or no effect.

I must confess that I have been puzzled as the yen continued to move higher versus the dollar throughout the year. I have been reading a number of reports on the currency markets, and as best as I can tell here is why the yen has been so strong:

  1. With global interest rates so low, the "yen carry" trade (borrowing in yen at low rates to invest elsewhere) has largely disappeared;
  2. Japanese exports have been much stronger than imports, thus creating a larger demand for yen;
  3. China is diversifying away from only US investments to investments in Japan, mostly Japanese government bonds (JGB's).
This last point is important from at least a couple of respects. First, it demonstrates the larger role that China is playing in Asian markets. And, second, although so far China has been a largely passive investor in JGB's, there is always the possibility that it might start playing a bigger role in Japan, especially since China is now the largest trading partner of Japan.

Oh, by the way: guess who was selling dollars in favor of the yen this morning (i.e. directly counter to the trade the Japanese were implementing)?

That's right: the Chinese.

It is clear that with their increased economic strength that the Chinese are becoming more assertive in the global markets. Not only are they directly intervening against the Japanese currency effort, they have also quietly ignored the strong desire on the part of the US for the dollar to weaken versus the renminbi. Here's the way the FT put it today:

Japan’s intervention is likely to heighten tension around the already charged issue of China’s persistence in holding down the renminbi, which is set to be one of the most contentious issues at the forthcoming meeting of the G20 group of countries in Seoul.

The US is disappointed that China has allowed the currency to rise by less than 1 per cent against the dollar after its decision to unpeg the renminbi in June. This week, the US Congress will hold hearings to investigate options for penalising Chinese imports or having the currency intervention declared illegal by the World Trade Organisation.

Tetsufumi Yamakawa, head of research at Barclays Capital in Tokyo, said Japan’s intervention “at least, would give a good excuse to China for not moving by claiming that the Japanese authorities are manipulating their currency [as well].”

Stay tuned.

FT.com / FT's rolling global market overview - Overview: Risk aversion lifts gold and yen