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Friday, July 14, 2006

Opportunities Arise with Expected BOJ Rate Hike

The BOJ is meeting today and is poised to hike interest rates for the first time in 6 years to 0.25%. If this happens, this will be more than just the scant 25bps rate hike that it is... it symbolizes that Japan has defeated deflation and is on a strong economic recovery, and might be a start of a long-term trend. It might also be officially the end of the yen carry trade.

When interest rates in Japan were effectively zero and the yen was weak, the BOJ was actually allowing investors to take money for free and creating so much liquidity that asset markets like emerging market equities, bonds and real estate rose so much. People have already anticipated the end of the yen carry trade, and emerging market (EM) currencies like the Turkish Lira, Indonesian Ruppiah, RSA Rand and Polish Zloty have already fell.

With the official announcement of the rate hike and the end of the yen carry trade, expect more weakness in EM assets. The Japanese stock market has also fallen due to rate hike jitters, some people fear that rising borrowing costs will stifle the rebound, though we think this is highly unlikely as the economy and corporate balance sheets are much stronger than 6 years ago. We feel the current and expected further correction will be an opportunity to buy ETFs like EWJ, EWZ and FXI. We feel these 3 markets have good domestic stories that will allow them to have better rebounds from a correction. The problem is the timing... how deep will the correction be?



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