[Jason_Lim]

Over recent days JPY crosses have moved higher led by AUDJPY. Traders expect further gains and recommend opportunistic long positions. JPY crosses are still viewed as carry trades, but the analysis of Japanese banks’ asset and liability positions suggests that banks have reduced their foreign claims over the past year and there are no signs that these claims are rebuild. Japanese banks’ risk appetite has been fragile for a long time, but up to last year banks had been happy lending to foreign based entities as these accounts were viewed as offer better credit compared to domestic Japanese accounts.

The catalyst for higher JPY crosses works via rising currency reserves and commodities which are linked to the rebound of the global economy and USD weakness. The combination of a global economic rebound and the weak USD drives commodities up. Rising commodity prices increase savings of commodity producing countries and these savings tend to be recycled into Western capital markets. In addition, USD weakness has not yet been accepted by Asian monetary authorities. China controls the USDRMB rate near 6.83 while other
Asian central banks have been busy intervening, selling domestic currencies against the USD. Global currency reserves have increased by USD630bln over the past year with USD400bln of this increase coming out of Asia. Incoming currency reserves have been allocated away from the USD, but since the JPY offers little yield and represents a deflationary economy, CB bank demand for JPY is less developed when compared to the EUR or even the AUD. Hence, central bank currency reserve reallocation often coincides with the JPY crosses moving higher.

This source of JPY cross strength is weaker when compared to the past when JPY supply was created by Japanese banks providing credit to foreign institutions oiling the carry trade.

Early next year we see JPY crosses trading significantly lower, with rising Asian inflation rates determining the timing of the bearish JPY cross trade. Once Asian
inflation picks up local central banks will loosen their grip on FX rates and increase interest rates. Currency reserve growth will slow reducing reallocation demand for euro and high yielding currencies such as the AUD. Alternatively, global currency reserves would decline if the Western economic rebound proves unsustainable.
True, the current economic improvement has come on the back of a fiscal expansion promoting domestic demand in the Western World. Cynics would argue that part of the Asian reserve increase has been funded by Western fiscal spending supporting local consumers buying Asian products.