Can A Forex Trader Profit Greatly From The Presently Undervalued Yen

The Yen, the Japanese currency has come under scrutiny from the major developing countries for its weakness.

Its weakness should not come as a surprise since the country has kept it that way it order to encourage growth which was lacking due to the downturn that occasioned the pricking of the 1980’s bubble in the early 1990’s.

In 1995 when the yen reached the Y80 to a $1 rate, Japanese manufacturers were crying for help. Toyota estimated for every Y1 appreciation against the dollar, it lost $50million.

At that time, the hollowing out of Japanese industry to South East Asia was gathering pace and with a weak economy, the then government had no choice but to begin a weak yen policy.

To achieve the weak yen policy, government started splurging in order not only to keep the currency weak but to use demand to pull the economy out of the woods. It also slashed interest rates to zero when deflation raised its ugly head.

This policy however did not pull the economy out of the woods but it did make the currency weak. Also demand did not rise because both consumer and business confidence was low due to the weak employment market and the huge bad debts carried not only by the banking sector but by other financial and non-financial institutions.

Also the Japanese started buying dollars in large quantities to keep the yen weak. This worked spectacularly but at a huge cost.

The question now is whether the weak yen policy makes sense, its sustainability and when will the yen begin its appreciation to a more realistic level. This is of primary interest to any forex trader as any positions taken can yield enormous returns.

With the reforms carried out over the past few years by the outgoing Koizumi’s administration, the economy is now enjoying a recovery

Best of all, the first price rises in ages have now been confirmed and this has made the government judge the recovery as sustainable.

With inflation, the government policy of zero interest rates may now be over. Interest rates have now been increased for the first time in several years though - to a tiny 0.25% but it is still significant. As any trader knows, an increase in interest rates normally strengthens a currency. Interest rates will continue to edge higher as the Bank of Japan is hawkish about inflation remembering that it was cheap money that fuelled the 1980’s bubble.

Secondly, the government has since commenced a policy of mopping up excess funds in the economy and this led to a 4% plunge in the stock market in a single week in 2006. The days of both cheap money and excess funds may be over.

And to add to all this, the era of massive deficit spending to is coming to an end. This anyway is no longer needed now that the economy is recovering and inflation is in sight.

With a tight fiscal and monetary policy, the currency will definitely appreciate. The question therefore is when and by how much?

Within the next two years, I foresee the yen appreciating between 5-10% against the dollar and the euro. Such a surge will not adversely affect the manufacturing sector as consumer demand is now playing a positive role in respect of demand thereby reducing the dependency on exports.

The yen may eventually hit or perhaps surmount the Y100/$1 barrier in 4 years time if economic growth stays at 3% annually over a period of 5years and if interest rates hits the 4-5% mark.

My advice to traders- better buy yen as an appreciation of the currency will definitely occur.