More About Japan and the Yen

The yen is drifting lower in the North American morning. If at first in response to the resignation of Prime Minister Hatoyama the yen was sold on political uncertainty, it may be being sold because of uncertainty appears to be diminishing and the more likely successor as prime minister is a person who is vocally in favor of a weaker yen.

It will be recalled that even before becoming finance minister, Kan advocated a weaker yen in general and not in the context of a particular move in the foreign exchange market. Kan is also a strong advocate of the BOJ to take more measures to combat deflation. Here too a decline in the yen is desired.

Some observers will attribute some of the blame of Hatoyama's resignation on the US government which pressed Hatoyama to abandon his electoral pledge about moving the Us Marines Corp base off of Okinawa. Kan, as prime minister, might be willing to overrule any objections the US may have for intervention. Kan may find a sympathetic air from some Europeans. Rather than dollar-yen being the source of frustration for Japanese investors and businesses, it is the euro-yen rate which has been more costly.

Dollar-yen volatility is trending lower after rising above 16.5% on May 20. Three-month implied vol is now near 13.5%. It is likely headed back toward 12% where it was before the May faux pas by Europe. The 3-month risk reversals show that investors were paying as much as 4% for yen calls over yen puts on May 21, which is the most extreme since last July. Now its stands at 2.8% and and is being reduced. Both the lower volatility and the lower skew in the risk reversals suggest only a low risk of dollar-yen intervention.

Euro-yen volatility remains elevated. It is above 20% currently (3-month). Put this in perspective by noting that the 100-day moving average comes in near 15%. The premium for yen calls over puts is above 5%. It hit almost 6.5% on May 21. This readings coupled with the slopes of the vol curve and risk-reversal skews suggest that the risk of intervention may be greater on euro-yen than dollar-yen.

In addition then to the political certainty (yen devaluationist likely coming to the helm) and uncertainty (yet another prime minister that couldn't last more than a year), and the (marginal) increase in intervention risk, but also the risk of a rating downgrade seems more likely because it is more difficult to envisage the will for strong fiscal actions.

The dollar is testing the JPY92.30 area, which is a retracement objective of the two day decline in early May that saw the dollar fall from almost JPY95 to a lost just below JPY88. A move above the JPY92.30 area would give immediate scope for another big figure increase toward JPY93.30.

While the euro is up almost 1% against the yen today, it has not taken out yesterday's high (~JPY112.85). A move above the JPY115 is needed to stabilize the tone.