"How can something so wrong - feel so right?"

There is clearly an enormous argument being played out in the press between Japan's central bank, its Ministry of Finance and the Japanese political establishment. This very public disagreement is absolutely crucial to global fund managers because it will dictate the direction of the yen this year. Being short (or underweight) the yen has been one of the most profitable things fund managers could have done in the past few years. Frankly, it's been easy money, especially when you can deploy the capital elsewhere in your portfolio in higher yielding assets like corporate bonds, emerging market debt and the like. In essence, this is the so-called "carry trade" and, being selfish, work-shy fops, most fund managers would like it to continue, thank you very much. If you come from a slightly Calvinist position, being rewarded for doing very little is very wrong indeed but as a guilty little pleasure - it feels so right.

Critically, the Bank of Japan keeps on citing "forward looking" analysis to stave off future overheating in the economy. The reason for this presumption is simply that the current data just doesn't support further interest rate increases;

It's not the kind of environment that would immediately require interest rates to be put up a lot, and yet there are those in the BOJ who would dearly love to do precisely that. No wonder the politicians are being more cautious, seeking evidence of an entrenched recovery before sanctioning rate rises.

Related to all of this is the question as to precisely whose interests it would serve for the yen to appreciate unilaterally against all other currencies? Western fund managers are desperate for a self-sustaining internal market place between the Far Eastern nations breaking the current dependency culture that sees all nations rise and fall with the same breathing pattern as the U.S. economy.

There is some evidence that exports from the countries within the region to each other is increasing, but the main game in town remains selling things to the U.S.

It would be better if the yen moved up against the US dollar as part of a generalized dollar decline rather than single itself out for special treatment. Parities could therefore be maintained between nations and not much damage would be done in the process - especially if it is a pseudo-coordinated movement. Inevitably, you end up doing a flow of funds analysis to find out who has the whip hand here. Much is made of the Japanese recycling of capital back to the U.S., but the reality is that the significance of this has been falling over the years and that the slack has been taken up by the Chinese.

So, key to the Japanese decision-making process is/should be maintaining a competitive yen/yuan rate. The yuan has appreciated against the yen (by about 25% in the past couple of years - see chart) and with the Chinese maintaining a policy of a managed appreciation at a rate of 4%-6% per annum, the Japanese won't be keen for the yen to appreciate unilaterally, because it will erode export competitiveness (which, frankly, is the only thing Japan has going for it right now). In effect, by obsessing about the yen/U.S. dollar rate we've been looking in the wrong place for our clues on the yen.

The bottom line is that we should put a big question mark over a sustained unilateral appreciation of the yen for the foreseeable future. This in turn will sponsor the continuation of the carry-trade, which has been such a driver of the bond markets in the past five years with all of the consequences for foppish fund managers.