On The Money

Why is the yen trending higher?

The dollar's recent rally may have been kicked off by a technical situation, but this time the fundamentals are in place for a bigger move. BY BARBARA ROCKEFELLER

The yen strengthened from 8123 (technically 0.008132), futures basis on June 14, 2007 to 9565 on Jan. 23 (17.8 percent in about six months). It's not the excellent performance of the Japanese economy behind this move, nor, conversely, the bad performance of the U.S. economy. What's going on?

"The hammer and the yen" (Currency Trader, July 2007) predicted the yen would follow the blue line in Figure 1. We continue to think the yen is on this track, but with the

FIGURE 1 — THE DOLLAR-YEN TRAJECTORY

Although it's following the general path of the trend forecast, the sporadic bursts of carry-trade unwinding that tend to occur every three or four days make the dollar/yen pair very choppy.

Source: Data — Reuters DataLink; charts — MetaStock

added boost of sporadic bursts of carry-trade unwinding. These are now tending to occur every third or fourth day, making the dollar/yen very choppy and yet following the overall trend.

Last July the sub-prime problem was only beginning to poke its head out of the bushes. Other factors seemed more important, including the Japanese government's announcement it wanted a stronger yen — something that would get the Group of Seven (G7) off Japan's back for having a weak currency that unfairly promotes exports, and would make the cost of imported raw materials denominated in dollars less onerous. Perhaps most of all, a strong currency denotes a strong economy and confers prestige.

The problem with a big-picture trend forecast like this is that you can't trade it. You could trade it if you are a deep-pocket trader and can sit cheerfully through drawdowns until the primary trend manifests itself, but that doesn't describe most traders. In fact, the yen is in the process of developing a counter-trend move right now that could last another two to four weeks, and maybe longer.

Figure 2 shows the dollar downtrend/yen uptrend with the associated retracements highlighted in the MACD indicator in the bottom window. Each surge downward is followed by a

The MACD highlights swings in the dollar downtrend/yen uptrend. Each big downswing has been followed by a smaller corrective upswing.

smaller corrective move upward. The first big move was from 123.63 (June 21) to 115.80 (Aug. 16) and it corrected back to 117.64 (Oct. 12), or about 38 percent. The second big move was from 117.64 to 108.19 (Nov. 28) and it retraced to 114.14 (Dec. 26), or about 62 percent. We are now seeing the formation of a corrective coun-tertrend move. If it were to take the dollar up 50 percent, the yen would hit about 110 (horizontal line). Such a big move would constitute a breakout of the linear regression channel, by the way.

We can also see the up move by drawing old-fashioned support and resistance lines (Figure 3). As of the first week of March, the range defined by the support and resistance lines is about 111-107, and the lines converge around the end of April at 108.40. In other words, we expect a breakout to the downside (for the dollar) before the end of April.

We dislike the word "cycle" when applied to securities prices for a number of reasons — not least no one has shown conclusively that cycles exist — but the yen chart since last summer is certainly making waves in what looks like a cyclical manner. What is occurring in the financial or economic world to influence the dollar/yen in this way?

The first obvious answer is accounting periods like month end, quarter-end, and year-end. The calendar year-end in Japan is March 31, and in some years we do indeed see repatriation continued on p. 18

Source: Data — Reuters DataLink; charts — MetaStock

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ON THE MONEY continued

FIGURE 3 — CONVERGING TRENDLINES

As of the first week of March, the range defined by the up and down trendlines is about 111 to 107, and the lines converge around the end of April at 108.40, implying a downside breakout.

Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec. |2008|Feb. |Mar. |Apr. |May June |July Source: Data — Reuters DataLink; charts — MetaStock

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flows back into the yen — but we do not see it every year, or even in the majority of years. Since many traders come to expect it, though, they buy yen in anticipation, and to some extent the "calendar year-end repatriation" story has become a self-fulfilling event. The yen spiked higher in March 2007, for example, but not in 2006. If there is going to be a yen-repatriation story this year, it will be running directly against the tendency of the yen to correct downward.

Another reason for the apparent cyclicality of the dollar-yen is that perception of the relative strength and safety of the U.S. dollar is driving it, and it doesn't have much to do with Japan at all. The first yen spike in August came at the time the subprime crisis was beginning to hit home in a big way and it was becoming clear the Fed would be cutting rates. The next spike was in November, when the Fed cut rates, and the third spike came around the time the Fed not only cut rates, but cut inter-meeting 75 basis points. You might say you can forecast the yen near-term by forecasting the Fed.

Still, something else is happening in the yen. Figure 4 shows the euro/yen uptrend from 88.96 (Oct. 23, 2000) to 169.10 (July 20, 2007) — one of the longest running trends in the history of floating currencies.

FIGURE 4 — EURO/YEN UPTREND

The euro/yen rally from October 2000 to July 2007 was one of the longest-running trends in the history of floating currencies.

Notice that the euro did spike lower in March 2007 (circle). It also spiked lower in August 2007 and in January this year, so a calendar year-end repatriation theory doesn't necessarily pass the "so what?" test.

After making a new all-time high in July 2007, the euro has failed to put in higher highs. It has instead put in a series of lower highs and higher lows. From this we can start a new linear regression channel that favors the yen. We can also draw support and resistance lines (converging to 168.50 in February 2009). In short, the yen is on a rising path against both key currencies, or perhaps we should say that the dollar and euro are both on a falling path against the yen.

Unfortunately, this is not explained by anything in the economic fundamentals. The Japanese government recently downgraded its outlook for the economy, noting that the Japanese economy is slowing down, in part from lower capital spending and lower industrial production under management that eyes the U.S. slowdown as bad for the export business. Wages in Japan (and household income) have not kept up with the growth of the past few years so that domestic demand is not robust enough to be a fallback position. Capital inflow from foreigners buying Japanese equities has recently been an unreliable source of yen demand, too continued on p. 20

FIGURE 4 — EURO/YEN UPTREND

The euro/yen rally from October 2000 to July 2007 was one of the longest-running trends in the history of floating currencies.

Source: Data — Reuters DataLink; charts — MetaStock

ON THE MONEY continued

FIGURE 5 — NEW LINEAR REGRESSION CHANNEL

After making a new all-time high in July 2007, the euro has put in a series of lower highs and higher lows vs. the yen. A new linear regression channel favors the yen, and converging up and down trendlines meet at 168.50 in February 2009.

After making a new all-time high in July 2007, the euro has put in a series of lower highs and higher lows vs. the yen. A new linear regression channel favors the yen, and converging up and down trendlines meet at 168.50 in February 2009.

Source: Data — Reuters DataLink; charts — MetaStock

FIGURE 6 — REUTERS CONTINUOUS COMMODITY INDEX VS. THE YEN

Source: Data — Reuters DataLink; charts — MetaStock

FIGURE 6 — REUTERS CONTINUOUS COMMODITY INDEX VS. THE YEN

The Japanese government wants a stronger yen to keep imported commodities from becoming prohibitively expensive and damaging industrial and manufacturing competitiveness. As the commodity index rises and the yen falls, the cost to producers in Japan rises not only by the dollar amount of the commodity price rise, but also by the amount of yen depreciation.

The Japanese government wants a stronger yen to keep imported commodities from becoming prohibitively expensive and damaging industrial and manufacturing competitiveness. As the commodity index rises and the yen falls, the cost to producers in Japan rises not only by the dollar amount of the commodity price rise, but also by the amount of yen depreciation.

Source: Data — Reuters DataLink; charts — MetaStock

— the week of Feb. 16 was the first in seven that foreigners were net buyers.

The one thing that explains yen firmness is the new policy orientation announced last year — the Japanese government wants a stronger yen to keep the price of imported commodities from becoming prohibitively expensive and causing a loss of industrial and manufacturing competitiveness. Figure 6 shows the Reuters Continuous

Commodity Index vs. the yen. As the commodity index rises and the yen falls, the cost to producers in Japan rises not only by the dollar amount of the commodity price rise, which is prodigious, but also by the amount of yen depreciation. As the yen rose during 2007, the commodity price burden on producers was reduced — just as the U.S. economy was seen as entering slowdown. Even though China is now the primary destination of Japanese exports, the U.S. is still a critical market.

So now we understand why Japan wants a stronger yen, but it's not clear how they achieve this end. It's not enough to state "we want a stronger yen," is it? The U.S. has been saying "strong dollar, best interests" for a decade now and it has failed to achieve that end. But Japan is different. We assume that behind the scenes, the government uses "moral suasion" to urge industrial and financial firms to repatriate earnings in a timely manner, not keeping surplus cash overseas, and perhaps even to restrain outgoing capital seeking higher returns. According to the Japanese Ministry of Finance's monthly reports, the yen is not being supported by official government intervention.

While we are unclear about all the mechanisms supporting the yen, the rough outline of support is visible on the chart. It would be unwise to bet on a falling yen except in the instance of the seemingly inevitable corrective coun-tertrend moves that are also so clear on the chart. O

For information on the author see p. 6.

Other Barbara Rockefeller articles:

"Fundamentals lead the charts," Currency Trader, February 2008.

The recent global market turmoil and banking crises have the financial world on edge, but their impact on the dollar might not be what most people expect.

"A fistful of dollars, a bundle of contradictions," Currency Trader, December 2007. The U.S. currency must resolve several paradoxes to emerge from its funk. One overlooked positive of the current situation may offer the depressed buck a way out of its bind.

"The road to 1.5," Currency Trader, November 2007.

The dollar appears to be under siege, but perhaps the situation isn't as grim as popularly believed.

"Helicopter Ben and the Japanese yen," Currency Trader, October 2007. The American and Japanese economies, and the fate of the confounding yen.

"The dollar's 'sub-prime' future," Currency Trader, September 2007.

The fallout from the U.S. housing and mortgage meltdown may be far from over, and how things unfold will have a big impact on the forex market.

"The rising yen — here we go again," Currency Trader, August 2007. The yen has been on the rise vs. the dollar. Find out if it's a reversal or just a correction.

"The hammer and the yen," Currency Trader, July 2007.

Recent statements by Japan's Ministry of Finance hint at big things on the horizon for the yen.

"Too big to fail," Currency Trader, June 2007.

If the dollar is poised to rebound, it might be getting help where it least expects it.

"Do stocks hold the key to currency levels?" Currency Trader, May 2007. The correlation between stock market and currency prices isn't what many people think.

"The coming commodity boom," Currency Trader, April 2007. Commodities are already having an impact on global economies.

"The yen: Canary in the currency coal mine," Currency Trader, March 2007. Keep an eye on capital flows and the yen — they could be telling you more about the dollar than first meets the eye.

You can purchase and download past articles at http://www.activetradermag.com/purchase_articles.htm.

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