The dollar rose against the yen as the market brushed off a weekend meeting of Group of 20 countries that discussed currency values but offered few surprises. The euro climbed broadly, pushing to near a record high against the yen after European Central Bank President Jean-Claude Trichet said the ECB has to be strongly vigilant on inflation risks, the typical signal that interest rates are set to rise.
“He said ‘strongly vigilant’, which called to mind the possibility that the ECB may continue raising interest rates next year,” said a senior trader for a major Japanese bank. The comments from Trichet, speaking after a meeting in Sydney of the Group of 10 top central bankers, helped trigger some unwinding of short euro positions, the trader said.
The single currency gained to 151.35 yen after rising as far as 151.46 yen — just below a record high of 151.48 yen matched last week. Traders in Tokyo were largely unfazed by a meeting of G20 financial leaders due to a dearth of comments about the yen.
“Some in the market had expected G20 officials to comment on the euro’s strength against the yen prior to the meeting,” said a trader. “But nothing regarding the euro came out, so the market shrugged of the meeting.”
The G20 said on Sunday after the two-day meeting that the world’s major economies face growing inflation risks but prospects for economic growth are strong.
The meeting also featured fresh calls for more foreign exchange flexibility. The G20 did not mention China by name when referring to currency policy, but officials signalled the group clearly had the economic superpower in mind.
The G-20 statement suggested that global growth is likely to slow somewhat in 2007, but that overall growth conditions will remain strong. It stated that rates will have to rise further especially in those areas and countries were monetary accommodation is still excessive and rates not yet at neutral levels – a clear signal that rate differentials will have to ease further.
ECB’s Trichet suggested that ‘financial markets might be under pricing risks’. This statement is seen as especially important in the context of the outstanding size of carry trades and financial market leverage. Friday saw yen and CHF buying on the back of hedge funds liquidating oil long positions funded in Yen. Recall that hedge funds have USD1.2 trn under administration and since these funds have been used primarily in YEN and CHF for building up leverage it suggests that the size of the outstanding carry trade is a multiple of the USD63 bln currently estimated by the BOJ. Hedge funds average leverage has exceeded four times capital in the past year.
The yen showed a muted reaction to comments from Japanese Vice Finance Minister for international affairs Hiroshi Watanabe, who said there were no reasons on the domestic side for further depreciation of the yen suggesting that the economy can grow over 2% this and next year. Watanabe tried to downplay the importance of yen funding saying that outstanding positions would only comprise ‘several trillion yen’. We continue to see Japanese authorities manoeuvring on a very fine line. On one hand they do not want to encourage the further build up of yen funding positions (hence the comments seeing no further reason for yen weakness) on the other hand authorities will have to avoid the sudden liquidation of yen funded positions. The market will remain sensitive on the issue especially after Friday’s events. Bear in mind that Japan’s basic balance (current account, long-term portfolio and FDI flows) trades at an historic surplus, suggesting that in the absence of building up any yen funding positions the yen will slowly move into an appreciation trend. Japan’s authorities will have to avoid a sudden increase in volatility, hence they will continue smoothing the market verbally.
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