Yen Firmer - Is Carry Ready to Unwind?

• Australian Dollar: drops on softer PPI
• Yen: starts the week strong after S&P Japan upgrade
• British Pound: softer on M & A flows
• US Dollar: nothing on calendar

Yen Firmer – Is Carry Ready to Unwind?
As this week began the S&P upgraded Japan’s debt rating to AA from AA- lending strength to the yen which was the best performer against the greenback in overnight trade. The agency issues three consecutive downgrades between 2001-2002, so tonight’s upgrade is a strong vote of confidence by the S&P regarding the long term prospects of the Japanese economy. It suggests that ratings agency believes that Japan has finally put its decade long battle with recession and deflation to rest and that the country’s economic growth will be sustained going forward.
The yen also gained on the back of some carry trade unwinding, as Australian PPI figures printed much softer than expected at 0.0% vs. 0.6% forecast. The currency market will wait until tomorrow CPI release to fully gauge inflationary pressures in the Australian economy, however today’s producer data along with Friday’s news on soft import prices indicates that price increases may be moderating allowing the RBA to remain neutral for a while longer.
Australian fiscal authorities are becoming uncomfortable with the high value of the Aussie. Last week Treasury Secretary Costello warned that the currency’s exchange rates were starting to hurt exporters. With Aussie having climbed to 17 year highs against the dollar last week on mounting speculation of not just one but two near term rate hikes by the RBA, any negative surprise in CPI could trigger an avalanche of profit taking in both AUDUSD and AUDJPY as momentum players bail out of the trade. All of this in turn should help the yen as the very same carry trades that hurt it in the past month begin to be unwound. Furthermore, if US equity markets recede from their record highs, the yen would only gain more strength on the move to risk aversion.

In Europe today, the action was incredibly quiet with little on the economic calendar to drive order flow either way. The pound saw some mild selling as a result of M & A news between Barclays and ABN Amro which pushed the EURGBP cross higher. In general, as the week commences, the dollar appears to be ready for a rebound after several weeks of relentless selling. However, we believe that the bounce will be distinctly of the dead cat variety as none of the structural issues that have dogged the currency shows signs of improvement. One source of solace for greenback bulls, may be this week’s housing data. If the numbers meet or beat expectations, talk of a some sort of a bottom in housing could help fuel a more sustained rally. However as the week wears on both Durable Goods and GDP report need to impress in order to convince the market that dollars are a buy.