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Ghost of 1990s is haunting the US dollar and slowing further gains

Friday, January 27, 2017 - 14:16

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A new dynamic entered the US$5.1 trillion currency market in recent days, as rising US Treasury yields failed to lure foreign investors in the last four months.

[TOKYO] Call it the ghost of US administration past.

A new dynamic entered the US$5.1 trillion currency market in recent days, as rising US Treasury yields failed to lure foreign investors in the last four months.

One reason: traders are increasingly aware of the example of the period in the Clinton administration when a widening yield advantage didn't work in the US dollar's favour, says Shusuke Yamada, chief Japan currency and equity strategist at Bank of America Merrill Lynch in Tokyo.

The underlying concern is that President Donald Trump's protectionist moves will likely be accompanied by a preference for a weaker US dollar, hurting foreigners' desire for American assets.

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That's essentially what happened in the early years of President Bill Clinton's administration, when US officials took aggressive moves against Japan on trade and the then-Treasury secretary expressed a desire for a stronger yen.

"It's been shared among market participants that there was a time when we saw dollar-yen falling while the rates differential widened," Mr Yamada said in an interview Friday.

"It's difficult for them to buy dollar-yen when there is a very unpredictable president."

Further repressing the US dollar has been lingering concern that, with Japan's disinflationary pressures starting to ease, the BOJ will consider tapering its mega stimulus, Mr Yamada says.

He anticipates such worries will be removed on Tuesday, when Governor Haruhiko Kuroda has the opportunity to make clear his commitment to easing after a policy board meeting.

The US dollar jumped against the yen in Tokyo morning trading on Friday after the BOJ boosted the size of a regular bond-buying operation - a move inconsistent with any tapering plan.

As for the Trump administration, traders may need to get some reassurance that the new team isn't going to talk down the US dollar. Treasury-secretary nominee Steven Mnuchin's confirmation by the Senate is still pending, and there may be more opportunities to hear his views after he takes office.

Mr Mnuchin, in oral and written responses to senators, has made clear he views "long-term" greenback strength as important, though an "excessively strong dollar" can sometimes have negative implications for the US economy.

Any step up in jawboning could be damaging, said Yamada, whose base case is for the US dollar to climb to 120 yen by spring, with the potential for an overshoot to as high as 130.

"That would have very strong implications on the demand for, for example, US Treasuries - would Japanese investors buy US Treasuries if the US government will talk down the dollar forever," Mr Yamada asked.

"Probably not."

For now, "it's a very subtle balance that they are taking," making things complicated for investors, he said.

"The clear implication is high volatility."

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