Market Overview

Yen Weakens on Hopes for Further Easing

Yen Weakens on Hopes for Further Easing

The yen is trading at its lowest level against the U.S. dollar in six months after Japanese prime minister Yoshihiko Noda held up his end of a bargain struck with the opposition parties and called an election for December 16. The Diet will be dissolved on Friday and campaigning will begin for the control of the House of Representatives (Lower House).

Japan had been facing its own fiscal cliff due to the refusal of the major opposition parties, the Liberal Democratic Party (LDP) and the Komeito, to authorize deficit spending for the current fiscal year, which ends on March 31, 2013, unless Noda, head of the ruling Democratic Party of Japan (DPJ) set a date for the election.

Japanese law requires that the Lower House specifically authorize deficit spending before the government is allowed to issue bonds to finance the deficit. The political stalemate had been jeopardizing the efforts to rebuild after last year's devastating earthquake and tsunami along Japan's northeast coast.

After a series of closed door meetings. Noda and the leaders of the LDP and Komeito announced that they had reached an agreement to authorize the deficit spending, avoiding a government shutdown. Although Noda did not announce the date of the election immediately, he did so within a few days.

Voters have lost faith in the ability of the DPJ to govern following a series of scandals and missteps before, during and after the earthquake. Most observers think that the DPJ will lose the election but there is little voter support for the opposition LDP.

In fact, the politics is getting really messy as there has been a rush of DPJ Diet members leaving the party, either to join the LDP or one of the two new parties that have been set up to attract DPJ defectors. At this point, it seems likely that the new government will have to be a coalition but it is anyone's guess how that will turn out.

That's the reality of the situation.

The market is selling the yen because, according to Bloomberg, Shinzo Abe, who was prime minister in 2006 and 2007 and leads the LDP today, “…called for the central bank to provide unlimited stimulus.”

“The leader of Japan's opposition is coming down quite heavily, saying what he would like the Bank of Japan to do in terms of easing and that's pressuring the yen,” Jane Foley, a senior currency strategist at Rabobank International in London told Bloomberg.

Reuters commented, ”Shinzo Abe, the head of Japan's Liberal Democratic Party and frontrunner in next month's election, wants the Bank of Japan to consider sub-zero interest rates and reverse the yen's strength.” The Reuters article continued, ““Signs that the LDP will step up efforts to weaken the yen if it comes to power prompted investors to sell the currency against both the dollar and the euro.”

The idea of negative interest rates is really just election rhetoric. Japan has had negative overnight rates several times during the height of the banking crisis about ten years ago and it wasn't pretty. Negative interest rates did not appreciably weaken the yen at that time.

What we can say is that the yen seems to have been somewhat overbought and was due for a correction. Even an LDP victory is unlikely to change Bank of Japan policy very much because, with interest rates already at zero, there isn't much more that a central bank can do.

Traders who want to play the yen's current volatility through ETFs should look at the Ryder CurrencyShares Japanese Yen Trust (NYSE: FXY) or the ProShares Ultra Short Yen (NYSE: YCS), both of which offer adequate liquidity for retail investors. The ProShares Ultra Yen (NYSE: YCL) and the Wisdom Tree Dreyfus Japanese Yen Fund (NYSE: JYF) a seem to be relatively illiquid at this time.

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