Tokyo. Japan’s intervention against yen strength for the first time in six years means even more liquidity for already flush global markets, paving the way for further gains in higher-yielding currencies against the yen. Currencies such as the Australian dollar are poised to break out of this year’s sideways struggle as the Bank of Japan’s move to inject funds without sterilizing their impact coincides with expectations for the Federal Reserve to boost its bond buying. Resilient growth in emerging markets and higher interest rates in countries like South Africa and Brazil are proving alluring to yield-seeking Japanese investors and market players around the world seeking to boost returns via carry trades. Even with the bouts of market volatility seen this year, carry trade strategies are proving a success because sharp market swings tend to be fleeting. Cross/yen pairs — such as Aussie/yen South African rand/yen and Brazilian real/yen — may be able to hold gains and extend them even if dollar/yen stays stuck near 15-year lows. Indeed, the liquidity that Japan is pumping into the markets from what is expected to be unsterilized intervention may provide more fuel to those funds seeking higher yields. When markets turned rocky in August after the Federal Reserve’s surprise decision to maintain the size of its balance sheet, the dollar jumped as stocks and commodities fell, suggesting the dollar is being used to fund carry trades. Both of these fit with the emerging pattern that the dollar could remain weak against the yen even as higher-yielding currencies resume their upward climb, as long as the economic slowdown worries do not spark a long slide in global equities. “As soon as risk appetite comes back, excess liquidity will have to go into some markets,” said Hiroshi Yokotani, portfolio manager at Tokio Marine Rogge Asset Management in London. “I’m sure investors will focus on interest rate differentials.” The yen has a history of weakening against higher-yielding currencies while firming versus the greenback in such situations. After the BOJ started quantitative easing in 2001 and the Fed slashed rates to then-record lows, the yen weakened against most other major currencies and continued to lose value up until the financial crisis struck in 2007. In the two years after the BOJ started easing, both the euro and the Australian dollar rose about 16 percent against the yen. The New Zealand dollar rose 29 percent. But the US dollar lost 6 percent. Thus, where capital moves easily across borders, ample liquidity in one country can flow to high-yielding currencies and risky assets rather than stimulating lending in a domestic economy. With the Fed appearing to be on course to embark on its second quantitative easing to shore up growth, the dollar’s outlook could be even bleaker.

Source