Thursday, March 8, 2007

Exchange Rate Fluctuations

From last week....

"In today's lecture, we talked about the huge decline in the stockmarket. In today's newspaper, one article said that JPY increased to 119 againstthe USD yesterday because of the US stock market. Since the stock prices reflectthe expetation of the company's future revenue, does it imply that the macroeconomy will experience a recession so that the US dollar will be weaker? Is the stock price one of the factor that influence the exchange rate? And what does the currency reflect in terms of an economy? When I read the newspaper, I always see that stock prices and exchange rates fluctuate a lot. In the daily chart or the weekly chart, it is very difficult to estimate the trend, but in the yearly one, we can see thetrend more clearly. What kind of information, index or policy will have the greatest impact in the long run?"

In the short run currencies can move significantly due to all sorts of different reasons. For example, interest rates in Japan are the lowest of any major currency. Therefore people tend to borrow Yen in order to invest in other countries where interest rates are higher. The amounts of money involved are huge, and any change in these flows can cause a large movement in the exchange rate in the short run. In the long run, things like expectations of the future macroeconomic performance of the economy should have a relatively larger effect on exchange rates. If the US does experience a recession, I would expect the USD to depreciate relative to other major currencies..... assuming that other major economies do not also have a recession at the same time.


curiousangela said...

Is it the so-called carry trade (borrow yen at a low interest rate and invest them somewhere with high interest rate)? Do you think it is carry trade that bring about the slump in the stock market around the world or the bad performance in the stock market that cause carry trade?
Thank you^@^ !

HongKongMacro said...

It is always very difficult to disentangle the cause and effect in the marketplace, as all the shocks are inter-related.

My view of what happened is this:
the stock market drop largely resulted from uncertainty about future growth in the US and Japan (China may have been a trigger, but that's another story...). Up until this, markets had been very stable for a long time, encouraging investors to take highly leveraged positions such as Carry Trade- i.e. borrowing money to increase the size of their asset holdings. As long as the exchange rate remains stable, it is much cheaper to borrow in Yen than in any other currency (Japan has the lowest interest rates in the world right now), so many investors would be borrowing yen to leverage their assets. Investors borrowing yen and then exchanging it into other currencies puts downward pressure on the Yen, so the Yen was at low levels.

When the stock market dropped, the more leveraged investors lost a lot more than those who were not leveraged. They would have been more likely to close out their positions, and repay the Yen they had borrowed. Buying Yen to repay their loans would cause the Yen to appreciate, as we saw last week.

Since then, the Yen has been depreciating again as investors are tempted to re-enter the carry trade (borrowing Yen and investing in higher yielding assets denominated in other currencies).

As long as the world economy remains stable and Japanese interest rates remain low, the Yen will probably remain weak or depreciate further. But as soon as there is a negative shock (for example, more bad news on the US economy), the Yen will shoot up in value again as Carry Trade positions are closed, as it did last time.

Ragnarok said...

The latest news:
The exchange rate between USD and JPY was 117.36 at 9:23 8th Mar 2007,with a shoot-up of 1.1070%.

ragnarok said...

At this stage, what will happen to China's currency policy concerning Yen's fluctuation? May I have your opinion?

curiousangela said...

Since yen is weak, car makers in Japan like Toyota can benefit a lot in the US market due to a cheap price. Do you think the appreciation of yen this time is also a response to the pressure from US domestic market??

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