Watching the markets spin

Currencies Japan struggles to compete

There has been plenty of talk of volatility in currency markets in recent months but, in reality, the major crosses have been stuck in the doldrums for the best part of two months. The yen is stuck in a trading range of ¥122 ' ¥126 against the dollar and the euro is trading in a range of $0.8400-$0.8800 against the greenback. Even sterling, which had a brief bout of the collywobbles shortly after the UK general election, has steadied to be little changed since late May.

However, there has been a shift in market perceptions, making it tough for all currency investors and traders to make decisions.

Since 1995, the US has adopted the 'strong dollar' policy advocated by the then Treasury secretary, Robert Rubin. However, recent pressure from US manufacturers and ambiguous comments from President Bush, along with comments from world officials stating that the dollar is too strong, have left markets wondering whether the US is about to back off from its policy.

Even if the US does back away from its policy ' which to be fair it probably did some months ago when new Treasury secretary O'Neill said he was not in favour of currency intervention ' it is likely the dollar will retain its strength. This is because despite all the problems in the US economy, it still appears to have the best chance of returning to normal levels of growth soonest. The one worry is likely to be further unrest in the emerging markets, particularly Latin America. That showed in recent weeks ' pressure in Argentina led to a sharp sell off against the Swiss franc and the yen. Even that is likely to prove dollar positive in the long run, as undoubtedly the dollar will eventually be seen as the safe-haven currency.

So, what currencies should investors look to hold? It still seems wise to hold dollars against the yen, as Japan looks under severe economic pressure. One analyst referred to the Japanese economy as a 'basket case'. Around the ¥125 level, the dollar still looks a buy, with many looking to see the pair break above ¥130. Against the euro, the picture is more mixed. Some still predict an imminent upturn for the single currency, with others still looking for further euro weakness. Considering the euro failed to make any serious headway during the recent bout of dollar weakness, the bears certainly seem to be in the ascendancy again.

Short-term trade recommendation:

Despite calls for a weaker dollar, President Bush's calls for the market to decide the dollar's level probably means they will decide to keep the dollar high. Japan still seems as if it will struggle to push through structural reforms, despite the Prime Minister's electoral success. Buy the dollar below ¥125, looking for a push toward ¥130. Euro weakness against the dollar still looks favourite, but uncertainty makes little value apparent in being short euros against the dollar.