Forecast to strengthen on the unwinding of the infamous carry trade, Japan’s weak yen will remain under pressure as long as oil prices stay high, according to ABN AMRO Morgans chief economist Michael Knox.
Forecast to strengthen on the unwinding of the infamous carry trade, Japan’s weak yen will remain under pressure as long as oil prices stay high, according to ABN AMRO Morgans chief economist Michael Knox.
The Bank of Japan’s drive to keep rates low in an effort to turnaround a decade of stagnant growth and deflation has propelled the carry trade, in which investors borrow cheap yen and invest in higher yielding currencies including the Australian and New Zealand dollars.
“Japanese interest rates have been as low as zero per cent, but have been lifted in recent months to half a per cent,” Mr Knox said.
“Institutions can borrow at those very low interest rates in Japanese yen and then lend into US dollar terms at say 5.25 per cent, which is the fed funds rate, or in Australian dollar terms, at 6.25 per cent.”
The end result, according to the Australian economist, should have been a strengthening of the yen relative to other currencies under the floating exchange rate theory.
So why is it that the yen remains weak?
According to Knox, it’s all down to how floating exchange rates are actually set.
“When we look at the determination of, for example the European exchange rates or the Australian exchange rates, we find that it’s determined mostly by financial matters - the level of relative interest rates and so on,” he said.
“However, the Japanese exchange rate is determined mostly by trade matters, and the most important individual traded commodity as far as the Japanese economy is concerned is the price of oil.”
Knox said the oil price is key to the yen since the world’s second-largest economy imports all of its oil needs.
“This need to import a large amount of oil means that as long as the oil price is high, the Japanese exchange rate will be weak,” he said.
“This means that people who are borrowing money cheaply in yen will still be able to pay it back at a low exchange rate. Because as long as the US dollar oil price is high for that length of time, the yen will be weak and the Japanese carry trade will continue.”
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The Bank of Japan’s drive to keep rates low in an effort to turnaround a decade of stagnant growth and deflation has propelled the carry trade, in which investors borrow cheap yen and invest in higher yielding currencies including the Australian and New Zealand dollars.
“Japanese interest rates have been as low as zero per cent, but have been lifted in recent months to half a per cent,” Mr Knox said.
“Institutions can borrow at those very low interest rates in Japanese yen and then lend into US dollar terms at say 5.25 per cent, which is the fed funds rate, or in Australian dollar terms, at 6.25 per cent.”
The end result, according to the Australian economist, should have been a strengthening of the yen relative to other currencies under the floating exchange rate theory.
So why is it that the yen remains weak?
According to Knox, it’s all down to how floating exchange rates are actually set.
“When we look at the determination of, for example the European exchange rates or the Australian exchange rates, we find that it’s determined mostly by financial matters - the level of relative interest rates and so on,” he said.
“However, the Japanese exchange rate is determined mostly by trade matters, and the most important individual traded commodity as far as the Japanese economy is concerned is the price of oil.”
Knox said the oil price is key to the yen since the world’s second-largest economy imports all of its oil needs.
“This need to import a large amount of oil means that as long as the oil price is high, the Japanese exchange rate will be weak,” he said.
“This means that people who are borrowing money cheaply in yen will still be able to pay it back at a low exchange rate. Because as long as the US dollar oil price is high for that length of time, the yen will be weak and the Japanese carry trade will continue.”
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