Japan and South Korea to End Currency Swap Amid Island Dispute

By FX Empire Analyst - Irit R
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The euro was still unable to regain lost ground on Tuesday due to investors’ concern about the lack of a bailout deal. Eurozone finance ministers stated that Spain would not require help despite investors’ high hopes of more financial backing for Spain’s embattled economy. Worry about corporate earnings also kept risk assets like the euro and emerging markets from rising during trading on Tuesday. Investors faced a market concerned about an economic downturn and slowing corporate growth.

During trading, the euro reached $1.2987 versus the United States dollar. Although it is stronger than on Monday, the euro is still a full cent lower than the two-week high it reached on Friday. After the United States released a lower than expected unemployment rate, the euro briefly rose until investor enthusiasm cooled. Against the Japanese yen, Europe’s currency exchange is presently trading at 101.70 yen. On Friday, it was at a two-week high of 102.80 yen.

Eurozone Ministers Meet

On Monday, top finance ministers in the Eurozone gathered in Luxembourg. Following this meeting, they defended their choice not to release a Spanish bailout plan. European finance ministers believe that the nation is enacting enough safeguards and finance measures to avoid a bailout package for the time being.  Despite this decision, many investors believe that a bailout will be sought at some time in the future. This expectation prevented the euro from being sold off and has allowed Spanish ten-year bonds to remain stable.

In Greece, the government is still having problems reaching a debt reduction plan. Negotiations have stalled as the Greek Finance Minister, Yannis Stournaras, requested that international lenders give the nation an extra two years to reach their budget goals.

Dollar Index Remains Steady

Versus a basket of other currencies, the United States dollar held steady at 79.55. This is higher than Friday’s two-week low of 79.103 and roughly the same as its level on Monday. For there to be a new uptrend, the dollar index must rise above the high of 80.147 it reached on October 10.

The greenback reached 78.35 yen during the trading session making it relatively unchanged since Monday. On Friday, the dollar gained to a two-week high of 78.88.

Australian Dollar Bounces Back

The Aussie gained 0.4 percent to reach $1.0233. It was aided by a rise in Chinese shares that helped it come back from a three-month low. On Monday, the Australian dollar was $1.0149. In the last few months, the Aussie has had to struggle against worries over China’s economy. As Australia’s largest export market, a weakened economy in China could heavily impact on the performance of Australia’s markets.

The Aussie traded at 79.50 yen during Tuesday’s trading session. This is the strongest support level for the currency pair since June of this year although many leading analysts believe that it could still fall further. From May to September, the Aussie made impressive gains that are now being lost in a short period of time. Analysts speculate that the Australian dollar could approach $1.0103 which would be a 50 percent retracement of the dollar’s levels in the earlier portion of this year.

Japanese and Korean Currency Swap

In October of 2011, Japan and South Korea began working on a currency swap that totalled $70 billion for the year. The goal of the currency trade was to provide stability for the two nations’ financial markets amid the debt crisis in Europe. New versions of the currency swap have been greatly reduced as the two nations argue over a territorial dispute. Official relations between Japan and South Korea have worsened since August. At that time, the president of South Korea, Lee Myung-bak, called for the emperor of Japan to apologize for colonizing Korea. The dispute was fuelled by an area of islands known as Dokdo in South Korea and Takeshima in Japan.

Many analysts believe that the end of currency trades was caused by the territorial dispute, but officials in the two countries deny this. In Japan, the finance minister said that extra stores of Korean won would be unnecessary. As a result, Japan is letting the agreement expire at the end of October. Korea has also said that reserves of the Japanese yen would be unnecessary. A Korean official stated that Korean markets have stabilized over the last year and created reserves of various foreign currencies. With this added financial safety net, exclusive currency swaps with Japan would be unnecessary.

Originally, the currency agreement was started following the Eurozone crisis. When the global economy drops, the Korean won generally follows. In September of 2011, the won fell more than 12 percent. By trading currency with Japan, South Korea was better able to navigate the murky world economy.

While Japan is arguing over ownership with South Korea, another string of islands has recently made the news. Known as Diaoyu in Chinese and Senkaku in Japanese, this collection of small islands is being bitterly fought over by China, Japan and Taiwan. Despite the ongoing dispute, Japan and China are still carrying on with their annual currency swap. Signed in 2002, it is valued at US$3 billion.

Emerging Markets Undervalued

The International Monetary Fund (IMF) recently released its World Economic Outlook. In its report, the IMF noted that most gains and losses have been consistent with the reorganization of the world’s marketplaces. This report pointed out that many emerging markets have significant external surpluses. Despite these surpluses, the currencies in these nations have not risen appropriately. Three of the nations listed were China, Thailand and Malaysia. These currencies are thought to be undervalued by the marketplace. Part of the unrealistically low value is due to their large stores of foreign currencies.

Vietnam and India were advised by the report to not loosen their monetary policy. These two nations as well as Japan should work on fiscal consolidation in order to achieve economic growth. The IMF forecasted that China would post growth rates of 7.8 percent for 2012 and 8.2 percent for 2013. This growth rate represents a 0.2 percent drop from the report released by the IMF in July.

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