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Yen trapped between debt downgrade, tighter credit

R. Janakiraman

THE market strategy of ``Buy the rumour, sell the fact'' was very much in evidence this week in the case of the Japanese yen. The currency came under selling pressure from Monday on rumours that the international credit rating agency, Fitch IB CA was about to downgrade Japan's local currency sovereign credit rating but when the announcement did come through on Thursday, the yen actually strengthened to yen 104.40 to the dollar, up almost one per cent from yen 105.57 in late New Yor k trade on Wednesday. This was attributed to a correction of the sell-off in anticipation of the downgrade. Throughout the week, rumours that Bank of Japan (BoJ) is about to tighten interest rates in Japan lent support to the yen.

The Federal Reserve Board's decision to leave interest rates unchanged in the US was in line with market expectations and had only a marginal impact on the dollar. The European Central Bank (ECB) conducted its first variable refinance rate auction and as the allotment rates were in tune with forecasts, it did not create any ripples in the forex markets.

Continuing the trend seen last week, the euro weakened on Monday to a low of $0.9294. A statement from the ECB board member, Mr. Eugenio D. Solans, that the euro zone had nothing to worry from a weak euro was also seen pressurising the currency. German P PI for May came in at +0.6 per cent over the previous month and up 2.7 per cent over the year, its highest reading since August 1991 but the market ignored the data.

On Tuesday, rumours of the Deutsche Bundesbank bidding for the euro at $0.9380 and some further short-covering pushed the euro up to $0.9470. The US consumer confidence index slipped in June to 138.8 from a revised 144.7 in May and from a consensus forec ast of 140.0. This also depressed the dollar against the euro.

The ECB's first variable rate refinancing auction had no surprises. The bank awarded 99 billion euros at a weighted average rate of 4.32 per cent p.a., while the marginal (lowest) allotment rate was 4.29 per cent. These were in line with the market expec tations and compared with the minimum bid level of 4.25 per cent set by the ECB. The smooth start of the auctions had a reassuring effect on the market.

The FOMC decision on Wednesday to leave the US interest rates on hold had only a marginal impact on the dollar as the decision had already been priced in.

The euro gained against the dollar on Thursday and Friday. The US first quarter GDP growth figure was revised upwards to 5.5 per cent from the previous estimate of 5.4 per cent. While this did not move the market, strong inflation data in Germany and Ita ly this week have fanned speculation that the ECB would have to raise the interest rates further. This, coupled with Bundesbank's reported bids for the euro on the electronic broking system pushed the euro to $0.9530 on Thursday and to the week's high of $0.9601 on Friday.In Japan, the yen looked up when Sunday's elections gave a narrow victory to the ruling LDP-led coalition and avoided the political uncertainty that would have followed a defeat. The Japanese Vice-Finance Minister, Mr. Haruhiko Kuroda, said on Monday, that the yen's rise to yen 103.91 per dollar last Friday did not reflect economic fundamentals and he warned that the Ministry would respond in the forex markets as needed.

This pushed the dollar higher. Further, when rumours hit the Tokyo market that Japan's sovereign debt would be downgraded, the dollar rose to yen 105.77. The Finance Minister, Mr. Kiichi Miyazawa, warned Moody's Investors Service that a downgrade could b e something the rating agency would have to regret. The agencies, in turn, denied the rumour and the dollar-yen rate remained in a narrow range on Tuesday.

Japan's industrial production in May came in below expectations on Wednesday. The reading was +0.2 per cent against market forecast of +0.6 per cent; however, the June forecast was revised up from 0.5 per cent to 1.4 per cent. The news lent some support to the dollar.

Rumours resurfaced again on Wednesday about an imminent downgrade by Fitch, IBCA. The yen was torn in two opposite directions as talk of a tightening by BoJ confronted the fears of a cut in the country's credit rating. A front page report in Asahi Shimbu n newspaper on Thursday indicated that BoJ could end its zero-interest rate policy as early as July 17, should the Tankan report due next Tuesday show sufficient strength in consumer spending.

Fitch announced on Thursday that it was downgrading Japan's local currency sovereign credit rating from `AAA' to `AA+' and affirmed the long-term rating at `AA+'. While this should normally be negative for the yen, the market had already shorted the yen on the rumour and the announcement came as the removal of uncertainty.

Traders noted with relief that all other ratings remain unchanged and shifted to focus on the prospects of a hike in interest rate in Japan. The yen actually strengthened to yen 104.40 to the dollar, up by almost one per cent from yen 105.57 in New York on Wednesday.

Apprehension of BoJ intervention around yen 105 level has been capping the yen's rise. On Friday, Japan's unemployment rate in May came in at 4.56 per cent against 4.84 per cent in April. After rising to yen 105.65 level, the dollar-yen rate dipped to ye n 105.12 on this news. On Friday, the dollar was ruling at yen 104.80 in the forenoon in Europe.

The pound sterling traded within a tight range on Monday. On Tuesday, demand for euros against the pound fuelled a sell-off in the pound and it fell to the week's low of $1.4942. Thereafter, a recovery set in and the pound rose to $1.5208 on Thursday. Ma rkets paid little attention to a slight fall in the GDP in the first quarter of 4.010 billions in the quarter (against a deficit of 1.545 in the previous quarter) was also passed over. Friday saw the pound in a narrow range around $ 1.5125.

The exchange rates ruling in Europe on Friday forenoon were: $0.9575 to the euro and $1.5125 to the pound and DM 2.0420, yen 104.80 and SF 1.6270 to the dollar.

Rupee trades in

narrow range

The rupee opened the week at Rs. 44.6725/6825 to the dollar and saw good FDI flows on Monday. The main inflow was about $ 180 millions from an Australian firm towards eight per cent stake in Himachal Futuristic Communications Ltd, which strengthened the rupee and prompted exporters to sell dollars. The rupee touched the week's high of Rs. 44.6375/6475 on that day.

Good corporate dollar inflows were seen on Tuesday but the rupee was restrained by FII outflows. After opening at Rs. 44.6650/6850 on Wednesday, the rupee weakened a bit in thin trading. On Thursday, although there were good inflows, the month-end dollar demand from corporates led the rupee to close lower at Rs. 44.6675/6750. The RBI was closed on Friday for annual accounts and in a quiet market, the rupee ended the week at Rs. 44.67/68 to the dollar.

The forward dollar premia opened firm on Monday with call rates remaining high. With the RBI setting the cut-off rate in the reverse repo auction at 13.05 per cent, the call rates closed around 13 per cent. After remaining at 13 per cent on Tuesday also, call money fell sharply to 7-8 per cent on Wednesday as the RBI allowed banks to maintain less than the mandated 65 per cent of the CRR level on June 29. This softened the forward premia as well. On Thursday, call money closed at seven per cent and the six-month dollar premium closed on Friday at 75 paise, or 3.3 per cent annualised. Liquidity at the end of the week was comfortable.

The foreign currency assets of the RBI have moved down for the 9th consecutive week. On June 16, they stood at $ 33.871 billions, showing a fall of $1.488 billions in this period.