The US dollar has remained somewhat range bound against the European currencies as of late, but it continues its dramatic… … fall against the yen following the new record high this summer of 125 yen per dollar. One dollar is currently (January 21) valued at just under 106 yen.

The sharp decline of the dollar yen following the strong move up in the first half of 2007 is related to a number of factors. The dollar has been significantly weak against most major currencies throughout the last year, thanks to housing and mortgage concerns. The yen has been steadily gaining strength as the Japanese economy has improved in the last six months. Additionally, the yen has surged against most high interest rate currencies thanks in large part to the carry trade unwind. Carry trading is borrowing a low interest rate concern, like the yen, to earn interest rate income with a higher rate concern.

The dollar has been notably weak with housing and mortgage struggles and the near future does not look any brighter for the greenback. In addition to continued bad news in already struggling financial markets, retail sales, consumer spending, and consumer confidence are all beginning to crack. These negative economic indicators are fuel for continues weakness of the US currency.

Carry trades using borrowed yen continue to unwind after most major currencies set record highs against the Japanese currency this past summer. Traders profited greatly from borrowing at the miniscule interest rate of the yen through much of 2007, but as the US and other global financial markets turned sour, traders looked to get out of risky investments. The process of traders jumping out of carry trading is called carry trade unwinding. The dollar has been a leader in this move thanks to its weakness.

The dollar yen has dropped about 20 pips in half a year. This incredible move has allowed traders to see strong gains, or devastating losses, depending on their ability to determine position early in the move. Interestingly, the Bush administration has maintained a strong dollar sentiment throughout much of his presidency. Recently, they have not commented much on currency.

Japanese leaders had aggressively looked to devalue the yen through early 2007, to give great opportunity for exports of Japanese goods due to their cheap global prices. During the peak summer carry trade, Japanese officials did begin to express concern about the weaknesses beginning too great. They weren’t hoping for such a drastic turnaround, however.

Going forward, all current indications are that the dollar should continue its weakness against the yen. The Japanese economy has stabilized and the US economy is showing indications of a potential recession. This economic mix, along with certain continued equity weakness is a prime recipe for carry trade and dollar declines.

As with any financial investments, nothing should be assumed. The sudden reversal of the carry trade came at a time when many wondered if equities and carry trade would ever peak. Financial markets were as strong as ever and carry trading was at its greatest heights before its rapid fall. The potential for a move back up for the dollar and carry trades rests with signs of a bottom in housing and mortgages, and indications that a recession would be avoided in the US. Markets move more on future expectations that current events. Thus, even if the US economy was to struggle for a while longer, if the future looked better, currency speculators would likely respond.

As for now, speculators are still looking to profit from dollar yen weakness. Americans are more concerned with credit concerns and recession, but continued dollar weakness will impact buying power in many markets. If consumer confidence falls, and the dollar grows weaker, retailers will suffer due to the loss of interest or discretionary spending from consumers. This could spell more trouble for the US economy. While Americans are finding it harder to buy goods and to travel overseas, US exporters are benefiting from increased interest from foreign buyers.

Market Recap

The Dow closed a somber week with another 59 point loss on Friday, to close at 12,099. President Bush laid out a fast acting tax rebate stimulus package designed to put $145 million in tax rebates back into the hands of low and middle class households. The package is designed to spark the economy by giving taxpayers back more of their income. Wall Street reacted with concern over the size of the government intervention. Markets were closed Monday in the United States due to the Martin Luther King holiday. Most major world markets were down largely based on concerns that US economic struggles will spread.

Neil Kokemuller
Monday, January 21, 2008
10:25 AM EST

Neil Kokemuller is an Associate Professor of Marketing at Des Moines Area Community College in Des Moines, Iowa, USA. He has a MBA from Iowa State University with a specialization in marketing.

Please note: The information provided in this article is intended for informational and entertainment purposes, and not as advice for financial decisions or investments. Actions taken on the basis of the information shared is at the sole risk and discretion of the individual. Currency investment poses significant risk of loss.