FX Strategies in 2006: U.S. Dollar Versus Yen

Abstract

Riding the early morning Metro North train from Grand Central to Greenwich on April Fool's Day 2006, Luke Anthony briefly pondered the revitalization of some of the once grand Harlem neighborhoods. But then his thoughts turned back to the task at hand: to form a cohesive view of the likely path of the Japanese yen. Was the dollar on one of its patented upward swings that would bring it to 140 ¥/$ before long? Or is the past year's dollar appreciation just a brief pause in a longer-term downward march as the record current account deficit drags it to the depths?

Excerpt

UVA-BP-0505

FX Strategies in 2006: U.S. Dollar vERSUS yen

Riding the early morning Metro North train from Grand Central to Greenwich on April Fool's Day in 2006, Luke Anthony briefly pondered the revitalization of some of the once grand Harlem neighborhoods. But then his thoughts turned back to the task at hand: forming a cohesive view of the likely path of the Japanese yen.

Historically, the yen/dollar (JPY/USD) exchange rate was best characterized by prolonged swings (Exhibit 1). From the huge dollar depreciation between 1985 and 1995, to the subsequent sharp dollar appreciation through 1998, depreciation into 2000, and appreciation until the end of 2001, Anthony had watched (and participated in) several long swings in the exchange value of the yen. More recently, the yen had appreciated from about 135 JPY/USD in January 2002 to 103 by January of 2005.

But then the dollar took a surprise turn. Indeed, for Bill Gates, Warren Buffett, and many of Wall Street's finest, the dollar pulled one of the nastiest surprises of 2005. The world's two richest men and most financial market prognosticators predicted that the dollar would fall in 2005, dragged down by the huge U.S. current account deficit. Many forecasters predicted that by year end a dollar would be worth far less than JPY100. They were all wrong. Although the U.S. current account deficit headed towards $ 800 billion in 2005, the dollar rose. It was up by 3.5% against a broad trade-weighted basket of currencies, the first rise in four years. Against the yen, the dollar did even better, appreciating by 14%, despite a “5 big figure” wobble in December.

Anthony wondered whether the dollar was on one of its patented upward swings that would bring it to 140 JPY/USD before long, or whether the past year's dollar appreciation was just a brief pause in a long downward march as the record current account deficit dragged it to the depths.

. . .

Keywords: exchange rate determination, capital flows