The Japanese Yen is fluctuating sharply against the USD at lower levels. The Euro is weakening against the USD. INR is feeling the effects of a strong USD and is threatening to test all time lows. The currency market volatility is hitting equities with the Nikkei down over 13% from highs. The Sensex and Nifty are seeing sharp fluctuations at higher levels.
June is expected to be a volatile month for markets as currency market volatility impacts every other asset class. Markets will have to ride out volatility in June to resume its broad directional trends.
The Japanese Yen is leading the currency market volatility. The Yen is down 28% and 33% year on year against the USD and Euro respectively. The Yen is down on the back of the Bank of Japan’s policy to double its monetary base over the next two years to achieve an inflation target of 2%. Japan is in a deflationary mode at present. Japanese ten year government bond yields rose to 1% levels from 0.55% levels seen in April 2013 on the back of the Yen depreciation. The benchmark Japanese equity index the Nikkei, hit a multi year high of 15600 on the 22nd of May 2013, a gain of 80% on a year on year basis, on the back of a falling Yen.
The Yen is now feeling the effects of the sharp fall. The currency is up 2% and 1.5% from lows against the USD and Euro respectively. The Yen strength from lows coupled with rising government bond yields has prompted large scale selling in the Nikkei that has come off by 13% from highs. The markets will continue to pull up the Yen as traders cut Yen depreciation bets and Japanese equities will see volatility given its sharp rise over the last one year. Japanese government bond yields will stabilize at around .85% to 0.90% levels as the Yen looks to strengthen further.
The Yen effect on markets is volatility rather than any directional trend change. The falling Yen value was accompanied by a sustained rise in equity markets in many countries across the globe including India. The Sensex and Nifty went up to a couple of percentage points off record highs as FII’s pumped in USD 3.2 billion into Indian equities in April and May. Dow, S&P 500 and Dax touched record highs in May. The higher levels of equity markets can see profit taking due to Yen volatility.
The INR at levels of Rs 56.17 to the USD is just 1.7% off all time lows of Rs 57.20. The INR is reacting to volatility in equity markets on worries of FII’s pulling out money from equities due to volatile currency markets. The broad USD strength against the Euro is also having an effect on the INR. The USD is up 1.5% over the Euro over the last one month and is up over 4.5% over the last one year.
US economic data are coming in highly positive with home prices rising by the highest levels seen since 2006 and consumer confidence at its highest level seen since 2008. US unemployment rate has come off from levels of close to 10% to 7.5% levels over the last couple of years. US economy has consistently been adding jobs on a month on month basis over the last two years. The strength of the US economy relative to recession and record unemployment in the Eurozone is leading to the USD gaining in strength against the Euro.
The Yen volatility is expected to be temporary and the currency will resume its downward trend, as the Bank of Japan will keep its commitment to double its monetary base. Equity markets will stabilize and start on its upward trend on hopes of a broad economic recovery globally led by the US. The INR is likely to stabilize at lower levels as volatility reduces across markets. USD will maintain its strength given strong incoming economic data.
Table 1. Market Movement May 2013