Thursday, 23 May 2013

Is the Bear Move in the Yen Coming to an End?

Ralph Shell, Excel Analyst

It looks like the Fed's debate about tapering has a long tail.  Just mention the word 'taper' and it seems some asset class is going to contract.  Last night it was the Japanese Nikkei 225 that sold off over 7%; this gave the equity bears some momentum.  European markets were down 2 to 3%, and now US equities are trading lower by .40 to .93%.

Perplexing as it may seem, we are now in a convoluted world where good economic news is interpreted as bad news for some markets.  Interrupt the flow of Bernanke's monthly
$85B injection and there may be a hissing sound as some of the bubbles start to deflate.

In the US, it looks like some of this money has been going into the oil market.  It has been baffling to me how record stocks of oil in storage, a slowing of global demand, and an increase in US production is bullish on oil.  Perhaps we now know why.

The sell-off in the WTI was restrained compared to what happened in Japan.  For the last six months the yen has been under pressure as PM Abe vows to conquer deflation with his version of QE.  A lower yen means higher corporate profits and higher stocks.  Hedge funds, alert to bullish opportunity, jumped aboard the Nikkei futures.  Higher prices meant the global funds became under weighted in Japanese equities.  They bought and the party continued.

For forex traders, the yen has had a beautiful trend with few costly head fakes.  The yen weakened from November when it was trading around 80 to a new low yesterday of 1.0372; it has since gone back up to 1.0172.  If we stay around this level, it will mean the USDJPY (FXY) made a key reversal this week.  The new USD high versus the yen followed a lower trade may bring some follow-through selling of the USD versus buying the yen.

Over the weekend, Economic Minister Akira Amari was asked about the value of the yen on a talk show.  He claimed he did not know but:

"...it's being said that the correction of the strong yen is largely completed. If the yen keeps on weakening a lot more, it will have a negative impact on peoples' lives."

Later, other Japanese policy makers denied the yen weakening is over, but this does suggest there is a policy debate.

The weaker yen does bring some problems - namely, higher import costs hurt the consumer.  While the car and electronic companies benefit, the consumer pays a higher price.  Also, the energy imports have become especially dear and are a drag on the trade balance. 

More important, though, is the higher cost of borrowing money.  Rates in Japan are still low, but they are rising.  In the last month, Japanese government bonds (JGB) 5-year yield has gone up 16bp to .37%, and the 10 year up 28bp to .85%.  Should PM Abe achieve his goal of a 2% inflation rate in 2 years, what will the borrowing rate be then?  Money is worth a premium above the level of inflation, and a larger premium if the market thinks inflation will continue to rise.

Remember, Japanese tax receipts only account for about 50% of the government spending.  In addition, the government needs to service the existing sovereign debt which is over $14T and growing.  This looming problem, not to mention the aging population, is what has made super bears on the yen.


Click to Enlarge USDJPY Daily Forex Chart

Yes, the recent COT report show specs are loaded on the short side, 130.8K contracts.  There may be some longs wanting to bank their profits, but sometimes what we see is what really exists.

This remains a bear market in the yen.  We suggest trying to buy a retracement in the USDJPY should the pair trade around the 100 level.  As always mind your money.
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