The yen, rather than the US dollar, could be the big winner from a loss of confidence in the euro as an international store of value.
More fund managers – a net 51% – believe that the yen is overvalued than any other currency, according to the latest Merrill Lynch global survey. This suggests that they are not positioned for further strength.
The perception that the yen is expensive may reflect its nominal effective (i.e. trade-weighted) exchange rate, which is only 3% below its all-time high reached in January 2008. A correct assessment, however, should be based on the real effective rate, i.e. adjusting for Japan's superior inflation performance. This remains below its long-run average – see first chart.
Relative monetary policies are an influence on currency performance. Real official interest rates (i.e. relative to the annual rate of change of consumer prices) are much higher in Japan than the rest of the G7. The 3.2 percentage point gap with the US is the largest since 1980 – second chart.
The Fed and ECB have responded to market turbulence by expanding the monetary base – see Friday's post. The Bank of Japan has yet to follow – third chart. Fed liquidity injections, if sustained, could limit further US dollar gains, deflecting upward pressure onto the yen.