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The yen has come under severe downward pressure, reflecting a major shift in market sentiment.

A further decline in the currency’s value now appears inevitable, and there appears to be a good chance the yen will hit 130 to the dollar later this month and give up further ground in May.

The yen is burdened by three key downside factors.

The first is that Washington apparently remains committed to a strong dollar and tolerance of a weak yen.

Dollar-yen rates have often been sensitive to shifts in U.S. policy and to market expectations of these shifts.

Second, there are indications that Japanese investors are resuming their investment in foreign securities in earnest. With few attractive investment sources available on the domestic market, they appear poised to increase their foreign portfolios.

The third factor is that, although yen-based sources have fallen to attractive price levels, the recent stock market plunge in New York has left U.S.-based investors with limited room to increase their Japanese portfolios.

The future direction of the yen now appears to hinge largely on developments on the Japanese government bond market.

With other sources of investment offering few incentives, a flow of investment funds has largely converged on the bond market.

Mirroring the rising flow of interest rate-sensitive money into the bond market, bond prices have tended higher in recent weeks, driving down yields to barely more than 1 percent. The uptrend could run out of steam, however.

An unexpected twist in market circumstances could trigger selloffs and force a broad “sell Japan” mentality to develop once again, sending bond and stock prices and the yen plummeting together.

Should bonds come under heavy selling pressure, the yen could hit its 1998 low of 147 to the dollar and weaken even further to 150.

There appears to be a 20 percent to 30 percent chance of a development of this kind occurring in the short term.

Barring this, I expect the yen to weaken to around 135 to the dollar, which has climbed past one major threshold after another in recent weeks and is now hovering around the 126 yen line, a level unseen since October 1998.

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