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Yen Continues In Range Bound Trade

The Japanese yen continues to meander sideways versus the USD, spending most of the time since the beginning of 2011 trading between 81 and 83.  Last year when the investment crowd was questioning the integrity of the global economic recovery. the yen was supposedly the destination for those seeking a safe haven.  Now, with the global equity markets continuing their rally, why is the yen continuing it's show of strength?

The Japanese economy, unlike most of its Asian neighbors, has a recovery that can be described as under achieving.  This week there have been some minor economic reports indicating the moribund  recovery will continue.  As an exporting nation, Japan is dependent upon demand from abroad, and most Asian nations have been raising rates, attempting to slow economic growth.  At the conclusion of the Chinese New Year holiday, the Chinese, Japans biggest trade partner, increased bank rates to 6.06%, up 25 basis points.

Japanese government debt, as we have often observed, ranks among the highest in the world, when measured as a percentage of the GDP.  With the continuing trade surplus, and the massive accumulated savings by the Japanese people, the government has been able to finance ongoing governmental expenditures at amazingly cheap rates.  Japanese two year notes yield .23%, compared to US rates of .78%.  Ten year notes are yielding 1.32 versus 3.65% in the US.  At this differential, will there not be a pick up in off shore demand for the $24B 10 year notes being auctioned this week?

The Japanese government needs to issue debt to pay for about one half of this year's operating budget, plus they have a need to refinance any debt that matures.  With rates as low as the current ones, any significant rate change would be higher.  It is interesting to note that China was a net seller of $2.15B of Japanese debt in December.  Since the interest rates paid in Japan are nominal, it would seem that the Chinese sale was a currency play, taking profits on a strong yen.

So far the upward basis in some global interest rates has not made it to Japan,  however any upward move in Japanese rates would wreck havoc.  The current political deadlock has obstructed a renewed attempt to get control of Japan's deficit.  Failure by Prime Minister Kan to achieve a compromise that will reduce the budgetary deficit may result in the termination of another Prime Minister.

 Should there be a spike of the Japanese rates, the Bank of Japan is looking at contingency plans.  One of the plans involves the purchase of government bonds, thereby increasing the money supply, a move similar to Bernanke's QEII.  This action would be in response to an extreme case should yields top 2.0% for 10 year notes.  Would the reaction of currency traders be as negative on the yen as they were on the USD when QEII was announced last September?  

Considering the severity of the Japanese budgetary shortfall, and global concerns for this problem, have markets have given the yen a pass?  How times have changed.  Going back to June of 2007 the yen traded above 120.  For currency traders though, 2007 might as well be another century.  But with the political uncertainty, and deficit problems, does it make any sense to be long the yen versus the USD at 82?  Periodically there have been some bear raids that give you an opportunity to buy a dip.  We wish to use these as opportunities to buy the USD and sell the yen.