By Nicholas Hastings
A DOW JONES NEWSWIRES COLUMN
LONDON (Dow Jones)--Look for more yen losses - unless, of course, developments in China, Iran or, for that matter, the U.S. come to the Japanese currency's rescue.
As recent figures from the Ministry of Finance in Tokyo suggest, carry trades have returned with a bang and with the Bank of Japan still showing little sign of accelerating rate hikes, especially after the latest consumer price data, the yen will remain vulnerable to continued selling.
The flow figures showed that while foreign interest in Japanese equities might have improved, Japanese interest in foreign bonds was even greater - with a net capital outflow from Japan last week totaling $303.2 billion, just about reversing the Y315.5 billion inflow the previous week.
"In an environment of increased risk appetite, carry trades are in vogue," said Sue Trinh, a senior currency strategist with RBC Capital Markets in Sydney.
"As such, negative bond flows continue to undermine the yen and will do so until the market turns risk averse," she added.
The trend for investors to borrow cheap yen to invest in higher-yielding assets has been encouraged by a rise in global risk appetite, which by some measures has risen back to levels last seen in February 2005.
And there is little sign that those cheap yen are going to get any more expensive right now.
"Given the low level of Japanese rates, the yen is likely to be favored as the funding currency of choice by many in a positive carry environment," said Trevor Dinmore, a currency strategist with Deutsche Bank in London.
Although the Bank of Japan lifted interest rates from zero for the first time in five years this summer, rates are expected to stay down at 0.25% for some time to come.
Bank of Japan Governor Toshihiko Fukui has made it clear that he isn't in any rush to tighten policy again, for fear of tipping the economy back into recession. Recent economic data suggests this could be wise.
New trade data Thursday, for example, showed a sharp decline in the country's surplus largely as a result of lower exports and increased import payments due to higher oil prices.
Mansoor Mohi-uddin, chief currency strategist with UBS in London, warned that with crude prices now stabilizing, a further deterioration due to slowing exports "would be a threat to our bullish yen forecasts, especially if it causes the Bank of Japan to stop raising interest rates."
Earlier Friday, consumer price data showed that inflation pressures remain even more subdued that expected. A rebasing of the CPI series put the July CPI rise down at 0.2% instead of the 0.5% that the market had been expecting.
This is expected to increase political pressure on the Bank of Japan not to hike rates again any time soon.
But some analysts reckoned that even if the central bank was looking at raising rates again, this might still not be enough to help the yen much.
"Tighter policy is not lifting the yen against the dollar and the euro, which might suggest that the wide gap in (interest) rates needs to be closed a bit more before the yen starts to look attractive," said Steve Barrow, chief currency strategist at Bear Stearns International in London.
A rise in risk aversion could play into the yen's hands. And that is where Iran comes in.
Despite the recent fall in risk aversion, which has given investors the appetite to seek higher yields elsewhere, there are other signs this week that flows might be tempered by rising concerns over developments in the Middle East.
As the market waited for Iran to respond to U.N. proposals for the country's nuclear program this week, risk aversion started to turn up again. Benedikt Germanier, a currency strategist with UBS in Zurich, reported that his bank's aversion index had risen to -0.62 from -0.76 Monday.
Deutsche Bank's Dinmore also warns against other threats to the carry trade. He noted that the correlation between foreign exchange movements and interest rates have now reached an extreme level that will likely fall back at some point.
Timing that fall could be difficult, however. Past reversals have taken months, whereas this time round, the high correlation is only two weeks old.
There is also, Dinmore pointed out, the high level of yen short positions - suggesting that investors could soon start wanting to cover them. But, he added, these positions are still not as extreme as those taken up in late 2005 during the last period of yen weakness.
In the meantime, the yen could find itself getting support from completely different quarters.
As September, and its round of international financial meetings loom, so does the risk of criticism over China's currency policy. With U.S. Secretary Henry Paulson scheduled to visit Beijing early in the month and U.S. Congress set to consider a bill introducing tariffs on Chinese imports at the end of the month, chances are that there will be increased speculation over China's yuan policy.
If that happens, the yen could benefit as it has in the past, acting as a proxy for its Chinese counterpart.
The U.S. could also provide some unexpected aid for the yen, as recent poor economic data raises the specter of a sharp slowdown next year. That could well leave interest rates markets starting to discount a fall, rather than a further rise, in U.S. interest rates and provide scope for the yen to rally against its U.S. counterpart.
The yen was getting a rough ride early Friday as the market reacted to the CPI numbers. The dollar was up at Y117.18 by 0645 GMT, from Y116.31 late Thursday in New York, according to EBS. The euro was also up at Y149.57 from Y148.67.
Elsewhere, the single currency slipped back to $1.2759 from $1.2783 as the market waits for Fed Chairman Ben Bernanke to give his latest thoughts on the economy in an address to the Jackson Hole symposium at 1400 GMT.
Bloomberg TNI FRX POV
Telerate 1066 or 1074
Thomson P/1066 or P/1074
(Nick Hastings has covered the foreign exchange markets and industry for over 15 years. Apart from his written commentary and analysis, he also appears on CNBC television in Europe, Asia and the U.S. He can be contacted on +44-20-7842-9493 or by email: firstname.lastname@example.org)
(END) Dow Jones Newswires
August 25, 2006 03:17 ET (07:17 GMT)
Copyright (c) 2006 Dow Jones & Company, Inc.