DJ Forex Focus: Yields Will Keep Yen Under Pressure

LONDON (Dow Jones)--Calls by Japan's ruling DPJ Party for a dollar up at Y120 may appear a bit excessive.

But, the party may yet get much of what it wants.

Pressure on the Bank of Japan to bend to the government's will and ease monetary policy will only intensify ahead of Upper House elections in July at the same time that normalization of policy in the U.S. becomes even more likely.

In other words, yield differentials between the U.S. and Japan will only widen and, in the near term at least, this could push the dollar back up to its 2010 high just under Y95.00.

See the yen's recent performance against the dollar:

For the moment, the yen is showing some resilience, helped in part by the failure of Greece's bailout package to ease investor concern over a wider sovereign debt crisis. As a result, the yen, which is still seen as the ultimate safe-haven currency, remains in favor.

Nevertheless, as recent data from the Chicago Mercantile Exchange shows, speculators still expect the yen to fall. They increased their net shorts in the currency last week to $5.6 billion, the largest position of its kind in the last two years.

The start of the new financial year this month, and the consequent outflow of Japanese investor funds in higher-yielding markets elsewhere, together with comments from Chinese President Hu Jintao, which suggest he isn't about to revalue the yuan now to keep the U.S. happy, are both going to play against the Japanese currency too.

Speculation in the last few weeks that China was on the verge of easing its yuan peg to the dollar, in effect making its exports less competitive, had helped to provide some support for Asian currencies in general.

But it is the interest-rate outlook that could well inflict the most damage on the yen, especially if it looks as though the DPJ is having an impact on monetary policy thinking in Tokyo.

"Expect the government will ramp up pressure on the Bank of Japan to engage in further quantitative easing," warned Lindsay Coburn, a independent consultant to ING Financial Markets.

The ferocity of the fight that could emerge between politicians and policy makers in Tokyo was evident Tuesday when a claim by Bank of Japan Governor Misaaki Shirakaw that fears of a double-dip recession had faded was immediately criticized by the DPJ.

A draft document from the ruling party said the country needs drastic monetary easing to wipe out deflation. It also suggested that the government set an inflation target of 2.0% and that it aims to keep the dollar up at Y120.

Even if the Bank of Japan does manage to resist pressure for further monetary easing in the months to come, the central bank is hardly going to be able to start tightening policy again in that political environment.

For the yen, this will only be bad news as market participants continue to await signs that the U.S. Federal Reserve is getting ready to hike rates given the strength of recent economic data.

Optimists are hoping that Federal Reserve Chairman Ben Bernanke may well nod in this direction during his Congressional appearance later in the day.

Early Wednesday in Europe, the latest upturn in global sentiment, driven by good earnings from Intel and strong Singaporean growth, has pushed the dollar up at Y93.43 from Y93.14 late Tuesday in New York, according to EBS.

The euro was also up at Y127.35 from Y126.63 and at $1.3633 from $1.3592 as investors relaxed a little more about taking risks.

Bloomberg TNI FRX POV

   Reuters   USD/DJ    Thomson   P/1066 or P/1074 

(Nick Hastings has covered the foreign exchange markets and industry for over 20 years. Apart from his written commentary and analysis, he also appears on Fox Business News and CNBC television in Europe, Asia and the U.S. He can be contacted on +44-20-7842-9493 begin_of_the_skype_highlighting              +44-20-7842-9493      end_of_the_skype_highlighting or by email: nick.hastings@dowjones.com)