Fx Strategies In 2006: U.S. Dollar Vs. Yen

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1. Assume it is April 1st 2006. Based on the case, build a compelling case for buying or selling JPYUSD Analysis of the Current situation During the first half of the decade of the 2000’s, the USD had appreciated. In 2005, the USD went against all predictions of the prognosticators and rose. Despite a terrible current account deficit (USD800), the USD is heading towards a 140 JPY/USD level. There are 2 main reasons to explain the USD level in 2005. The first one is that thanks to a rising interest rates policy led by the FED (4.75%), the USD rose. Indeed high interest rates attracted Foreign Direct Investments (FDI), for example when the oil price increase a lot of oil exporting countries received a surplus in dollars and invested this surplus in US treasury bonds, and it helped to keep a strong USD. In the same time, the bank of Japan (BoJ) kept its interest rate close to zero. But expectations are not very confident for the USD. In fact, high interest rate leads to an increase in the currency which attracts FDI but it hurts exports. In 2005, the US current account deficit was heading towards USD 800 billion. With such a deficit, the US won’t be able to sustain a strong USD. We are going to develop 2 scenarios. The first one will describe a situation where the USD depreciates against the JPY, after the BoJ increased its interest rates. The second one will describe a situation where the USD will appreciate against the JPY thanks to low interest rates in Japan. Scenario 1: BoJ interest rate grows up to 4.25% In this scenario, we assume the dollar is going to depreciate against the yen. Therefore, we are considering a situation with high interest rates settled by the Bank Of Japan (BOE). Our assumption would be a rate set at 4.25%. This situation will imply various consequences for the

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