Yen poised to gain as global slowdown takes toll

TOKYO, Sept 3 - The yen is snapping an eight-year slide against the euro and Australian dollar as the abrupt global economic slowdown forces investors to unwind long-entrenched positions, pushing these currencies into a downtrend.

The sudden shift in the outlook towards interest rate cuts in economies such as the euro zone took investors by surprise, spurring them to cut back on risky carry trades using the low-yielding yen to buy high-yielding currencies.

The move has also coincided with the dollar's broad recovery, with the spreading weakness beyond the United States forcing some investors to abandon bets on a "decoupled" global economy. Most major currencies, oil and commodities have tumbled.

The Japanese currency rallied about 3 percent against the Australian and New Zealand dollars this week and 2 percent against the euro.

The sharp drop in higher-yielding currencies against the yen is likely to persist until investors fully factor in the global economy's deterioration. Even Japan's steady investment abroad that has kept the yen weak may not be enough to offset such selling pressure.

"Selling of yen crosses is driven by the shift in focus to economic weakness in countries where inflation concerns had supported views for rising rates," said Kimihiko Tomita, head of foreign exchange for State Street Global Markets in Tokyo.

Nowhere has that been more stark than in Australia, where the central bank cut rates by a quarter-point this week to 7 percent just six months after raising them. The abrupt shift in expectations sent the Aussie dollar sliding 9 percent against the yen in August -- the biggest monthly drop in a decade.

"Among the weak economies, currencies of countries with bigger surprises have more scope for falling for now, with investors scaling back risky investments," Tomita said.

The yen hit a two-year high against the New Zealand dollar and a five-month high against the Australian dollar on Wednesday, even as Australia and New Zealand still offer the highest interest rates among developed nations at 7 percent and 8 percent, respectively.

Australia's rate cut was the first in seven years, while New Zealand trimmed rates in July for the first time in five years. Both countries' central banks are expected to cut rates further.

Sterling and the euro touched five-month lows against the yen as more investors see the European Central Bank and the Bank of England lowering rates in coming months, with inflation concerns easing after oil's 30 percent fall from its record peak in July.

"Investors are unwinding positions in the yen crosses on the growing view that these currencies have now entered a medium- to long-term downtrend," said Hiroshi Yoshida, a trader at Shinkin Central Bank.

PEAKING OUT

Analysts say the euro, sterling, Aussie and kiwi all appear to have entered downward trends from long-term peaks, and technical charts were also seen pointing to more weakness.

The euro was likely to eventually break below a rough 150-170 yen range in place since November 2006, said Masashi Hashimoto, senior analyst for Bank of Tokyo-Mitsubishi UFJ.

"For now, levels around 150 yen are coming in to view," he said.

The euro hit a five-month low of 156.27 yen on Wednesday, well off the record high of 169.97 yen in July.

The kiwi appears to have entered a downtrend after breaking below long-term trendline support stretching from the October 2000 low of 41.87 yen through its May 2006 trough of 67.75 yen, Hashimoto said. The kiwi has also fallen below its 12-month moving average, which has itself turned lower.

"It may be a trend where we will see it fall for several months or perhaps for a year or two," he said of the kiwi/yen. The kiwi's downtrend adds pressure on the Aussie, which fell to a five-month low below 90 yen .

But the dollar's own rise against major currencies should limit how far it falls against the yen.

SURPLUSES AND DEFICITS

To be sure, some analysts say the weakness of higher-yielding currencies against the yen may not be sustainable and is due mainly to hedge funds and other players cutting positions.

"For the yen crosses to stay on a sustained downtrend, global slump must continue for a long time and oil and commodities prices must keep falling, both of which appear unlikely," said Takahide Nagasaki, chief foreign exchange strategist for Daiwa Securities SMBC.

But others say that even if oil prices bounce back later this year, investors are unlikely to return to commodity currencies like the Australian dollar with the same gusto as before.

"Let's say it turns out that the world economy is not in as bad shape as feared and people start to say commodities will go up. If such a rise actually takes place, then that will cool demand," said Taisuke Tanaka, chief Japan foreign exchange strategist for Lehman Brothers.

Such a situation can lead to heightened market volatility, which tends to make investors cool on higher-yielding currencies.

If investors start to worry about the current account deficits of Australia and New Zealand in a more fragile global environment, that may make Japan's surplus alluring.

"The yen is in a favourable position from supply and demand aspect, as Japan, unlike the U.S., enjoys a huge current surplus," said Tomita at State Street.