Coping With A Zombie Currency. By Nicholas Hastings

Like a zombie that just can't be stopped, the yen will continue marching relentlessly higher.

This poses a dilemma for the Japanese authorities, who have already started verbal intervention to at least, slow the rally, and likely hasten further easing in Japan's monetary policy.

The reason for the yen's zombie-like quality is simple. The currency remains a safe haven in times of global uncertainty.

Every time the confidence of international investors has started to rise in recent months, it gets knocked back, putting paid to any interest they may have been showing in higher risk assets.

The latest, and probably the worst knock back came this week, when Federal Reserve Chairman Ben Bernanke confirmed what recent U.S. economic data has been suggesting--that the U.S. recovery is stalling and the Fed may have to ease monetary policy even further.

Not only did this send equity markets lower, despite the recent wave of strong second quarter earnings, but Bernanke's comments also pushed two-year U.S. Treasury yields to a new record low at 0.54% and made dollar assets even less attractive on a yield basis.

The problem for international investors is that if U.S. recovery is stalling, the global economy will more than likely falter too, making riskier assets that much less attractive.

Recent data may have supported the view that Japan has been growing during the second quarter, with a rise in the all-industry-activity index out of Tokyo on Thursday boosting forecasts that the economy will expand during the second quarter by even more than the 1.2% growth seen in the first three months of the year.

However, the dollar's decline from about Y95 early May to under Y87 will eventually take its toll on growth, especially on the export sector that is vital for the Japanese recovery.

Under normal circumstances, growing fears of a double dip recession in Japan as well as the renewed threat of deflation would do the trick and bring the yen back down of its own accord.

Not now, though.

In a world once again dominated by risk sentiment and fears of fresh global downturn, the yen will continue to rise as it has before, with investors turning to the currency for its safe haven qualities rather than as a measure of the Japanese economy.

In the past, the threat of market intervention by the Bank of Japan, as the dollar sinks ever closer towards Y85, may have discouraged investors from pushing the yen any further. But, with Japan keen not to upset the U.S. administration by pushing the dollar higher while China is still preventing its currency from rising too much, chances are that market intervention will only be sanctioned by the Japanese government as a very last resort.

See the dollar's steady fall against the yen in recent months:



This knowledge will make haven seekers even bolder about buying the yen and ensure that any verbal intervention is even less effective than before, as deputy finance minister Motohisa Ikeda found on Thursday when he attempted to warn the market that the government will head off excessive yen strength.

Early Friday in Europe, as financial markets wait for the final results of the European bank stress tests, the yen has eased back a little against the dollar and the euro. The improved sentiment is largely the result of stronger than expected euro zone as well as U.S. data Thursday as well as more strong second quarter earnings reports that have lifted global stock markets and improved risk appetite.

However, most market moves are expected to be limited ahead of the stress test results. Although most banks are expected to pass the tests, there is growing concern that the tests themselves will be seen as too easy.

By 0645 GMT, the dollar had risen to Y87.04 from Y86.93 late on Thursday in New York, according to EBS. The euro was up at Y112.17 from Y112.05 but down at $1.2883 from $1.2892.

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 or by email: nick.hastings@dowjones.com)