Outlook of Yen (GIC, Paris) June 17, 2010 DIAM Economic Research 1

Outlook of Yen

June 17th, 2010Arranged for Global Interdependence Center, 2010 International Conference in Paris

DIAM Co. LtdChief Economist

Kozo Koide

Outlook of Yen (GIC, Paris) June 17, 2010 DIAM Economic Research2

Recent Move of YEN, Within a Range 2010 : Range from about 89 to 95 yen/$

< $/YEN Rate (Daily) >

86878889909192939495969798

09.08

.03

09.08

.1709

.08.31

09.09

.14

09.09

.2809

.10.12

09.10

.26

09.11

.0909

.11.23

09.12

.07

09.12

.2110

.01.04

10.01

.18

10.02

.0110

.02.15

10.03

.01

10.03

.1510

.03.29

10.04

.12

10.04

.2610

.05.10

10.05

.24

10.06

.07

Data:Bloomberg

$/Yen

DIAM Economic Research

11/29: Fujii after Dubai Shock:"watch & see"

8/30: Landslinding Victory of DPJ

9/24: Fujii (Minister of Finance, at themeeting with Secretary Gaithner)"FX market is a stronghold of free

12/1: BOJ introducednew liquidity supply facility

1/8: Kan (Minister of Finance, at inauguration)"Cheap yen is preferable"

1/21: Obama "Volker Plan"

3/3: Greece "Aditional cut of fiscal budget"

5/6: ECB, not discuss thepurchase of government bonds

6/2: Resignation of Hatoyama

3/31:The end ofJapanese FY

Outlook of Yen (GIC, Paris) June 17, 2010 DIAM Economic Research3

YEN Pendulum in the Last Decade YEN has been appreciated due to flight to ‘quality’.

– Financial crisis invited higher risk premium upon deficit countries’ currency.– Interest rate differentials or external imbalance. Japan : Low interest rate but

has large current surplus. Capital mobility matters.

< $/YEN Rate >

859095

100105110115120125130135

00.01

00.07

01.01

01.07

02.01

02.07

03.01

03.07

04.01

04.07

05.01

05.07

06.01

06.07

07.01

07.07

08.01

08.07

09.01

09.07

10.01

10.07

Source:BOJ

\ $／

010,00020,00030,00040,00050,00060,00070,00080,000FX Intervention by Japan(RHS)

＄/Yen Rate

DIAM Economic Research

Pariba Shock

Lehman Shock

Dubai Shock

100MYen

GreeceCrisis

Outlook of Yen (GIC, Paris) June 17, 2010 DIAM Economic Research4

Real Interest Rate Differentials & $/YEN Not instant sensitivity with $/Yen exchange rate, though...

– But it has become higher in about the last 5 years.< $/Yen Rate & Real Interest Rate Differentials >

▲ 5▲ 4▲ 3▲ 2▲ 1

01234567

85.01

86.01

87.01

88.01

89.01

90.01

91.01

92.01

93.01

94.01

95.01

96.01

97.01

98.01

99.01

00.01

01.01

02.01

03.01

04.01

05.01

06.01

07.01

08.01

09.01

Data:Datastream, Ministry of Internal Affairs & Communications(JPN), Department of Labor(US)

％

1.9

2.0

2.1

2.2

2.3

2.4

2.5Short-term real interest rate differential (3MLibor, US -- JPN)$/Yen (Monthly Average,LHS)

DIAM Economic Research

LOG10

US

> JP

NU

S <

JPN

More Sensitive

Outlook of Yen (GIC, Paris) June 17, 2010 DIAM Economic Research5

Break in Causality : Interest Rate & FX From mid 2008, the causality has been weakened.

Fig.Granger-Sims Causality Test帰無仮説 : 「金利差第一主成分から月次リターンへのGranger因果性が無い」

過去5年間（月次）のローリングウィンドウによる推定/lag=6

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

02/2

8/20

05

05/3

1/20

05

08/3

1/20

05

11/3

0/20

05

02/2

8/20

06

05/3

1/20

06

08/3

1/20

06

11/3

0/20

06

02/2

8/20

07

05/3

1/20

07

08/3

1/20

07

11/3

0/20

07

02/2

9/20

08

05/3

0/20

08

08/2

9/20

08

11/2

8/20

08

02/2

7/20

09

05/2

9/20

09

08/3

1/20

09

11/3

0/20

09

02/2

6/20

10

P-Va

lue

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

P-Va

lue

AUDUSD

EURUSD

GBPUSD

CADUSD

Lower CausalityInterest rate gap to FX rate

Miziho-DL Financial Technology

Outlook of Yen (GIC, Paris) June 17, 2010 DIAM Economic Research6

Current A/C Surplus & $/YEN Rate Higher Yen regardless of contraction of current surplus

< Current A/C of Japan & $/YEN Rate >

1.9

2.0

2.0

2.1

2.1

2.2

2.2

2.3

2.3

2.4

87.09

88.09

89.09

90.09

91.09

92.09

93.09

94.09

95.09

96.09

97.09

98.09

99.09

00.09

01.09

02.09

03.09

04.09

05.09

06.09

07.09

08.09

09.09

10.09

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

$/YEN Rate JPN:Current Account / Nominal GDP (4QTotal %, RHS)

Outlook of Yen (GIC, Paris) June 17, 2010 DIAM Economic Research7

Capital A/C : Portfolio vs. Others Large swing of portfolio investment & other investment

< Capital Accounts (6Mts, Total) >

▲ 400,000▲ 350,000▲ 300,000▲ 250,000▲ 200,000▲ 150,000▲ 100,000▲ 50,000

050,000

100,000150,000200,000250,000300,000

02.0

1

02.0

7

03.0

1

03.0

7

04.0

1

04.0

7

05.0

1

05.0

7

06.0

1

06.0

7

07.0

1

07.0

7

08.0

1

08.0

7

09.0

1

09.0

7

10.0

1

Source:MOF

100 Mil. YenPortfolio Investment Financial DerivativesOther Investment FDIOther Capital Accounts Capital Account

DIAM Economic Research

Outlook of Yen (GIC, Paris) June 17, 2010 DIAM Economic Research8

Japanese, not Taking Much Outright FX Risk Bank & pension are using more hedging operation Growing mutual fund take more FX risk

– But the majority is going to emerging &/or high interest rate zone. 【Outward Portfolio Investment (Equity & Long/Mid-term Bond)】

▲ 100,000

▲ 50,000

0

50,000

100,000

150,000

200,000

250,000

01.09

01.12

02.03

02.06

02.09

02.12

03.03

03.06

03.09

03.12

04.03

04.06

04.09

04.12

05.03

05.06

05.09

05.12

06.03

06.06

06.09

06.12

07.03

07.06

07.09

07.12

08.03

08.06

08.09

08.12

09.03

09.06

09.09

09.12

10.03

10.06

Source:MOF

100M\Life Insurance Bank(including Banking A/C of T/B)Trust Bank (Trust A/C) Mutual FundOthers Total

DIAM Economic Research

12 mts. Total

Outlook of Yen (GIC, Paris) June 17, 2010 DIAM Economic Research9

US$/YEN, & Effective Exchange Rate YEN, not so appreciated against ‘other’ currencies.

< Yen Exchange Rate >80

90

100

110

120

130

140

150

160

00.0

1

00.0

7

01.0

1

01.0

7

02.0

1

02.0

7

03.0

1

03.0

7

04.0

1

04.0

7

05.0

1

05.0

7

06.0

1

06.0

7

07.0

1

07.0

7

08.0

1

08.0

7

09.0

1

09.0

7

10.0

1

10.0

7

Source: BoJ, Bloomberg

40.00

50.00

60.00

70.00

80.00

90.00

100.00

110.00

120.00

US$/YENAUD$/YENNominal Effective Exchange Rate (RHS)

Jan. 2000 = 100

DIAM Economic Research

Outlook of Yen (GIC, Paris) June 17, 2010 DIAM Economic Research10

Unwinding of Yen Carry has been Stabilized Bank’s interoffice flow has become neutral.

【Other Investment ex.Trade Credits (6mts. Total) 】

▲ 300,000

▲ 200,000

▲ 100,000

0

100,000

200,000

300,000

06.01

06.04

06.07

06.10

07.01

07.04

07.07

07.10

08.01

08.04

08.07

08.10

09.01

09.04

09.07

09.10

10.01

10.04

Source:BOJ

100M\

Bank's Interoffice Account(L/T) Other L/T LoansSecurities Lending Bank's Interoffice Account(S/T)Repurchase Agreement ＆ Others OthersCurrrency & Deposit Other Assets/LiabilitiesOther Investment (ex. Trade Credits)

DIAM Economic Research

IN

OUT

Outlook of Yen (GIC, Paris) June 17, 2010 DIAM Economic Research11

About 7Qs Time Lag From 1998 : Average time lag between current A/C & Yen was 21mts

-6

-4

-2

0

2

4

6

8

5 10 15 20 25 30 35

Response of YENEFFECT to CholeskyOne S.D. CURRENTAC Innovation

Outlook of Yen (GIC, Paris) June 17, 2010 DIAM Economic Research12

Current A/C Surplus & $/YEN Rate If we assume a time lag for 7Qs before moving rate...

< Current A/C of Japan & $/YEN Rate >

1.9

2.0

2.0

2.1

2.1

2.2

2.2

2.3

2.3

2.4

87.09

88.09

89.09

90.09

91.09

92.09

93.09

94.09

95.09

96.09

97.09

98.09

99.09

00.09

01.09

02.09

03.09

04.09

05.09

06.09

07.09

08.09

09.09

10.09

11.09

Source : Cabinet Office, BOJ, Bloomberg

Log101.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

$/YEN RateJPN:Current Account / Nominal GDP (4QTotal %, RHS,7Qleading)

DIAM Economic Research

Outlook of Yen (GIC, Paris) June 17, 2010 DIAM Economic Research13

Cristal Ball, with Many Colors Current level is higher than ‘fundamental’ value, but...

– 59, 70, 98, 105, 113

< PPP Rate of $/YEN >

6080

100120140160180200220240260280

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

Data:Datastream, BOJ , Ministry of Internal Affairs & Tellecommunication(J PN), DoL(US)

$/Yen

$/YEN RatePPP(CGPI & PPI final goods)PPP(CPI core)

Outlook of Yen (GIC, Paris) June 17, 2010 DIAM Economic Research14

Yen Bull, Pushed out of the Edge of a Cliff ?

Outlook of Yen (GIC, Paris) June 17, 2010 DIAM Economic Research15

Shaky Greece & Yen Volatile Greece government bond market 　　　 higher

yen < $/Yen・Greece Government Bond >

86878889909192939495

09.11

09.12

10.01

10.02

10.03

10.04

10.05

10.06

Source Bloomberg：

0.01.02.03.04.05.06.07.08.09.010.011.0

$/YenVolatility of Greece government bond yeild(10ys,RHS)

DIAM Economic Research

(Note)Volatility : S.D. of daily change (30DMW)

Outlook of Yen (GIC, Paris) June 17, 2010 DIAM Economic Research16

BOJ, Took a Step Ahead BOJ has introduced new liquidity supply on Dec. 1, ’09.

– The near-term direct effect against deflation is restricted.– But affected the expectation in the market about future policy.– Planning new initiative for corporate finance

【O/N Call Rate ・ Reserve Account in BOJ (Monthly Average)】

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

98.04

98.10

99.04

99.10

00.04

00.10

01.04

01.10

02.04

02.10

03.04

03.10

04.04

04.10

05.04

05.10

06.04

06.10

07.04

07.10

08.04

08.10

09.04

09.10

Source ： BOJ

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80BOJ Reserve Account O/N Call Rate (right scale)

DIAM Economic Research

100M\

（Note）Shadow : Target of BOJ Reserve Account

％

Outlook of Yen (GIC, Paris) June 17, 2010 DIAM Economic Research17

JGB : Japanese Market 9 ４ % of outstanding was held by Japanese (incl. FILP

bond)– Due to the large domestic savings under deflation, JGB has been held

stably by domestic investors. – What is the implication of KAN-sian policy?< G7:Current Account / General Gov. Balance (% GDP) >

▲ 7.0

▲ 6.0

▲ 5.0

▲ 4.0

▲ 3.0

▲ 2.0

▲ 1.0

0.0

1.0

▲ 4.0 ▲ 2.0 0.0 2.0 4.0 6.0 8.0

Source: IMF DIAM Economic Research

CY2008( General Gov. Balance (% of GDP) )

( Current Account (% of GDP) )

Japan

GermanyCanada

France

Italy

US

UK

Outlook of Yen (GIC, Paris) June 17, 2010 DIAM Economic Research18