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Yen’s rise vs. US dollar is ending, says Citi

14 Dec 2010

Next year will herald the beginning of the end of yen appreciation against the US dollar, FX strategists at the US bank believe. The Asian currency has risen to near historical highs against its US counterpart this year.

Following months of continued appreciation the Japanese yen has hit a peak and will not continue to rise against the US dollar for the coming few months, predicts Citi.

Primary drivers for this view include the fact the Japanese exporters will hedge against their US dollar exposure at slower rates than this year.

A slogging of hedging trades should discourage further speculative buying of yen from hedge funds and interbank dealers who took advantage of the US dollar selling and the exporters’ need for yen, said Osamu Takashima, Japan FX strategist at Citi.

In addition, Takashima believes the recent decline of the US dollar against the yen to very close to historical lows should compel longer-duration investors—pension funds, insurance companies—to start purchasing foreign bonds but not hedge the currency risk.

One of the key reasons for the notable yen strength in the last six months was the huge levels of hedging by Japanese exporters, in which they set up put options to sell dollar at a certain level. As the dollar continued to weaken the sell orders were not filled.

The speculators would have sold US dollars in the market to push the dollar lower, and subsequently further away from the put option strike levels of the exporters. In order to square off their short dollar positions they would need to eventually buy back US dollars but at a cheaper rate as the dollar continued to weaken.

“Speculators became aware of the unfilled sell orders so they sold [the US dollar] further and a vicious circle was formed...pushing the US dollar/Japanese yen exchange rate to just below ¥80,” Takashima said.

Cit now believes this cycle has probably come to an end with most exporters selling their dollar exposure when the exchange rate rebounded to levels around ¥82.

“Exporters are now mostly finished hedging for the remainder of the fiscal year,” said Takashima. “They are no longer under-hedged and will not begin to sell [the US dollar] again until February when they decide on internal budget rates for the next fiscal year.”

On the institutional side, Citi expects investors to utilise the strong yen to buy foreign bond investments. At present the interest differential between Japan and the US is low because of low US interest rates—this makes hedging relatively cheap.

When US rates increases, so will FX hedges for those buying offshore. This, Citi believes, will make hedging less attractive and mean that some investors opt to not hedge. It also believes that investors will unwind the hedges they have on existing US bond investments.

“The unwinding of hedges cause a large amount of US dollar buying, which would firmly cement a bottom for the [currency pair],” Takashima said.

14 Dec 2010