BOJ Helpless as Yen Rises on Carry, UBS, Barclays Say

By Ron Harui and Stanley White

Nov. 6 (Bloomberg) -- The Bank of Japan may be powerless to prevent the yen from rising to a 13-year high, according to the world's biggest foreign-exchange traders.

Deutsche Bank AG, UBS AG and Barclays Plc predict the yen will recover from its steepest weekly decline since 1999 as investors reduce carry trades that fund purchases of higher- yielding assets by borrowing in Japan. The currency will appreciate to 90 per dollar from 97.74 today in Tokyo even if the Bank of Japan intervenes to stem the biggest annual gain since 1998, they said.

``Once the market realizes that we're now in a global recession, there's further deleveraging to come,'' said Geoff Kendrick, a senior currency strategist in London at UBS, the second-biggest trader in the $3.2 trillion-a-day market. Traders ``are capitulating'' after five years of bets against the yen, he said in a Nov. 4 interview.

The currency's 14 percent gain against the dollar this year and 30 percent advance versus the euro prompted Japan's government to announce last month it may buy or sell currencies to influence exchange rates, as the world's second-largest economy stumbled. Gross domestic product shrank by an annualized 3 percent in the second quarter as exports dropped 2.5 percent, according to government data.

Canon Profit

Canon Inc., the world's largest camera maker, blamed the yen's rally when the Tokyo-based company forecast its first profit decline in nine years last month. Sony Corp., the second- largest maker of consumer electronics, said net income fell 72 percent in the quarter ended Sept. 30. Tokyo-based Sony gets 77 percent of its revenue outside Japan, according to data compiled by Bloomberg.

The yen's real effective exchange rate, a measure of its value against 15 of Japan's trading partners, rose 11.2 percent in October, the biggest gain since the Bank of Japan started the index in 1970.

Finance Minister Shoichi Nakagawa said last month Japan was prepared to restrain the yen, which would be the first time the government has bought or sold currencies to influence exchange rates in four years. The BOJ, which trades on behalf of the Ministry of Finance, sold 14.8 trillion yen ($151 billion) in the first quarter of 2004, when it traded as high as 103.42 per dollar. The currency still ended the year stronger, at 102.63.

``An intervention to change the yen's rising trend would be like trying to stop a tsunami with one hand tied behind your back,'' Toru Umemoto, chief currency analyst in Tokyo at Barclays Capital, said in an interview on Oct. 28. The unit of London-based Barclays Plc is the third-largest foreign-exchange trader.

Biggest Traders

The currency pared its advance in the past eight days as global stocks rallied, reducing pressure on the government to step into the market. The yen traded at 97.74 at 2:41 p.m. in Tokyo, compared with 90.93 per dollar on Oct. 24, the strongest since 1995. It climbed 0.3 percent today.

UBS says the yen will rise to 90 per dollar in a month. Deutsche Bank, the largest trader, sees that level reached this year, while Barclays' forecast is for six months. The banks are outliers on Wall Street, where the mean estimate for the yen is 99 at yearend, according to a Bloomberg survey. UBS expects the yen to rise to 119 per euro at year-end, from 125.99 today. Deutsche Bank forecasts 113 and Barclays predicts 120.

Carry trades grew during the past five years, driving the yen to 124.13 in June 2007, as central banks increased interest rates to fight inflation while Japan kept its key rate at 0.5 percent. Investors borrowing in the yen could sell the currency and profit by buying assets in Australia, where policy makers raised benchmark borrowing costs as high as 7.25 percent in March from 4.25 percent in 2002.

Losing Favor

The strategy lost favor as the financial crisis caused banks and financial companies to report $693 billion of losses and writedowns since the start of 2007 and curbed demand for higher-yielding assets. Slowing economies also hurt the carry trade as central banks lowered interest rates to prompt growth. The Reserve Bank of Australia slashed its rate by 2 percentage points since Sept. 2, and the Bank of Japan cut its rate by 0.20 percentage point last week.

The dollar may drop as low as 80 yen if it penetrates the 90 level because Japanese investors are losing appetite for overseas investments and need to hedge bets from the past decade, wrote Masafumi Yamamoto, head of foreign-exchange strategy in Tokyo at Royal Bank of Scotland Group Plc, in an Oct. 27 note to clients. The yen climbed as high as 79.75 on April 19, 1995, as the bursting of a stock and property market bubble prompted the nation's investors to bring money home.

Limited Damage

Investors are favoring the yen because Japanese institutions avoided the worst of the credit-market crisis. Losses in Asia totaled $27.2 billion, according to data compiled by Bloomberg.

Japan's recession will be shallower than the U.S. and Europe because damage from the global credit crisis has been limited, Jun Saito, the Cabinet Office's top economist, said in an interview yesterday in Tokyo.

The yen may also strengthen because of so-called power reverse dual currency notes, said David Deddouche, a foreign- exchange strategist for Paris-based Societe Generale SA, France's second-largest bank.

PRDCs combine exchanges of interest-rate payments with options granting the right to buy and sell currencies. The products, which typically have a duration of 25 years or more, pay a fixed coupon the first year and then pay rates that rise when the yen depreciates and fall when it strengthens.

Sellers have the right to cancel the contracts early should a weaker yen push interest payments above a certain level. With yen gains preventing the exercise of this option, banks that sold the contracts have been left with 25 years or more of payments that they may have to hedge as much as $100 billion related to the trades by buying yen, Deddouche said.

``The hedging flows are quite amazing and will hurt officials trying to intervene,'' he said.

To contact the reporters on this story: Ron Harui in Singapore at rharui@bloomberg.net; Stanley White in Tokyo at swhite28@bloomberg.net