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July 3, 2013

Japanese Yen Down on Risk Aversion. The Correction against the Dollar will Continue.

Filed under: Japanese Yen — Tags: , , , , , , , — admin @ 3:56 pm

It seems the gods of the forex market read my previous post on the Japanese Yen, in which I puzzled over the currency’s appreciation in the face of contradictory economic and financial factors. Since then, the Yen’s 6-month, 15% appreciation (against the US Dollar) has arrested. It has retreated from the brink of record highs, and undergone the most significant correction since March of this year. Have investors come to their senses, or what?!

USD JPY Chart
You certainly can’t give the Bank of Japan (BOJ) any credit. Aside from its single-day $25 Billion intervention in September, it hasn’t entered the forex markets. In fact, it has already repaid the funds lent to it by the Ministry of Finance, which suggests that it doesn’t have any intention to replicate its earlier intervention in the immediate future, regardless of where the Yen moves.

Perhaps the BOJ foresaw the current correction in the Yen, which was probably inevitable in some ways. After all, Japanese interest rates – while gradually rising – still remain at levels that are unattractive to investors. While US short-term rates are low, long-term rates are more than 1.5% higher than their Japanese counterparts. When you factor in that Japan’s fiscal condition is worse than the US, there is really very little reason, in this aspect, to prefer Japan. As one analyst summarized, “The whole interest-rate differential argument is turning out to be dollar supportive, at least in the near term.”

The same is true for risk-averse capital. For reasons of liquidity and psychology, the Japanese Yen will continue to be a safe-haven destination in times of distress. Still, it’s hardly superior to the Dollar, in this sense. Inflation is slowly emerging (or at least, the risk of deflation is slowly abating) in Japan, and it could conceivably reach 1% this year if the Bank of Japan has its way. Its proposed 35 trillion yen ($419 billion) of asset purchases dwarfs the comparable Federal Reserve Bank’s QE2 program (in relative terms) and contradicts the notion that the Yen is the best store of value.

Japan Economic Structure - Dependence on Exports
Finally, the Japanese economy remains weak, and vulnerable to a double-dip recession. On the one hand, “Japan’s economy expanded at an annual 4.5 percent rate in the three months ended Sept. 30.” On the other hand, its economy remains heavily reliant on exports (see chart above, courtesy of Bloomberg News) to drive growth, which is complicated by the expensive Yen and concerns over a drop-off in demand from China and the rest of the world. In fact, “Exports rose 7.8 percent in October, the slowest pace this year, while industrial production fell for a fifth month and the unemployment rate climbed to 5.1 percent.” In addition, the closely watched Tankan survey registered a drop in September, “the first fall in seven quarters.” While Japanese companies are still net optimistic, analysts expect that this to change in the beginning of 2011.

For the rest of the year, how the Yen performs will depend largely on investor risk-appetite. If risk aversion predominates, then the Yen should hold its value. In addition, it’s worth pointing out that even as the Yen has fallen against the Dollar, it has appreciated against the Euro, and remained flat against a handful of other currencies. Against the US Dollar, however, I still don’t see any reason for why the Yen should trade below 85, and I expect the correction will continue to unfold.

JPY comparison chart 2010

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July 2, 2013

Japanese Yen Due for a Correction in 2011. Fundamentals Suggest a Bubble in the Yen.

Filed under: Japanese Yen — Tags: , , , , , , — admin @ 4:00 pm

Based on every measure, the Japanese Yen was the world’s best performing major currency in 2010. It notched up gains every one of its 16 major counterparts, and was the only G4 currency to appreciate on a trade-weighted basis. Against the US Dollar, it rose 10%, and touched a 15-year high in the process. However, there is reason to believe that the Yen is now overvalued, and that 2011 will see it decline to more sustainable levels.


I am still somewhat baffled as to why the Yen has risen so inexorably. It is said that “Hindsight is 20/20,” but in this case the benefit of hindsight doesn’t really provide any additional clarity. Of course, there was the Eurozone Sovereign debt crisis and the consequent shift of funds into safe-haven currencies, but let’s not forget that the fiscal problems of Japan are even more pronounced than in the EU. Premiums on credit default swaps signal that the probability of a Japanese government default is twice as high as it is for the US, and there are rumors of a downgrade in its sovereign credit rating. As one commentator summarized, “Just how the Japanese have got away with running up a debt to GDP ratio of over 200% (higher than the PIIGS and the U.S.) is beyond me.” Of course, it helps that this debt is financed almost entirely by domestic savings and is consequently not vulnerable to the changing whims of foreigners, but even so!

Meanwhile, the opportunity cost of investing in Japan is high. While inflation is moot, equity returns are low and bond yields are even lower. “Japanese 10-year yields, the lowest among 32 bond markets tracked by Bloomberg data, will end 2011 at 1.24 percent from 1.19 percent today, according to a weighted forecast of economists surveyed by Bloomberg News.” Combined with low short-term rates, it would seem that the Japanese Yen would be the perfect candidate for a carry trade strategy.

Although foreigners remain net buyers of Japanese Yen, the current account/trade surplus is gradually narrowing, with the former falling 16% year-over-year and the latter dropping 46%. It seems that “consumers overseas increasingly spurn Japanese products in favor of lower-priced goods from South Korea and other nations.”


Even the Japanese seem to prefer other currencies. According to NIKKEI, “Japanese investors were net buyers of foreign mid- and long-term bonds to the tune of 21.94 trillion yen in 2010, the most since comparable data began being compiled in January 2005.” Japanese companies are also taking advantage of the expensive Yen and strong balance sheets to buy overseas assets. The Economist reports that, “Japanese companies are sitting on a hoard of cash totalling more than ¥202 trillion ($2.4 trillion)…Many companies have earmarked vast sums for acquisitions in 2011 and beyond.”

With GDP projected to fall to 1% in 2011, there would seem to be very little reason to continue buying the Yen. According to the most recent CFTC Commitment of Traders Report, speculators are building up massive short positions in the Yen. Meanwhile, the Central Bank of China is quietly paring down its Yen holdings. Even the Bank of Japan seems to have embraced this inevitability, as it is has already stopped intervening in forex markets on the Yen’s behalf.

According to a Bloomberg News Survey, “Japan’s currency will tumble almost 10 percent against the dollar this year.” Very few analysts think that the bottom will complete fall out from under the Yen, but the majority (myself included) expect a correction of some kind.

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July 1, 2013

Ratings Downgrade has a Muted Impact on the Japanese Yen. When is the Correction going to Begin?

Filed under: Japanese Yen — Tags: , , , , , , , , — admin @ 3:58 pm

Last week, S&P fulfilled rumors by lowering the Sovereign credit rating of Japan. The move immediately sparked headlines filled with words like “roil” and “turmoil,” and analysts predicted the beginning of a massive correction, like the kind that I forecast in January. I decided to wait a few days before posting on this story, in order to wait for the dust to settle. I’m glad I did, since the Yen’s stubborn refusal to slide further beggars some kind of explanation!

In hindsight, the Yen’s 1% fall during that day’s trading session was modest by any standards, despite the financial media’s attempt to characterize it as extraordinary. Even those analysts which conceded that the decline in the Yen was pretty mundane argued that depreciation would begin in earnest after the forex markets had a chance to digest the full impact of the downgrade. Simon Derrick, senior currency strategist at Bank of New York Mellon told the Wall Street Journal, “I would not be surprised if there is a second wave of yen weakness associated with the New York open.”

As much as one would have expected the downgrade to make a bigger splash, there are a couple of explanations for why it didn’t. First of all, the move was relatively modest – from AA to AA- – and S&P indicated that there wasn’t any risk of further downgrades in the immediate future. Second, as I reported in mid-January, rumors of a rating cut have been circulating for quite some time. When you look at the abysmal state of Japanese government finances, it was really only a matter of time before the rating agencies woke up to reality. Japanese public debt is projected to reach a whopping 204% of GDP this year, and according to S&P, it has no “coherent strategy” to address the problem.

Most important, the majority of Japan’s sovereign debt (~95%) is held by domestic investors, which means that the impact of any foreign capital flight would have been extremely limited. Due to perennially low interest rates, Japanese savers have few options but to stash their cash in Japanese government bonds, the yields on which hardly budged as a result of the downgrade and are still extraordinarily low.

It’s hard to say whether this situation will change. On the one hand, a substantial portion of Japanese investors seem to recognize that keeping money at home is a losing proposition. “According to the Bank of Japan, individuals held about 4.83 trillion yen ($58.87 billion) in foreign-currency deposits at Japanese banks as of the end of November last year, up 2.8%from a year ago and the highest since the central bank started providing the data in April 1999.” Due to an aging population, increased appetite for risk, and widening yield differentials, this trend is projected to continue for the immediate future.


On the other hand, all of this capital outflow is necessarily already reflected in the Yen, which has remained strong in spite of the carry trade. Perhaps the Japanese economy has been underestimated. While the current account surplus has showed signs of narrowing, it nonetheless remains a surplus. Perhaps that’s because Japanese companies are have proven that they are capable of adapting to the rising Yen, by either lowering costs or shifting production abroad. While Japanese retail investors move money abroad, Japanese companies are repatriating a steady stream of profits back home.

Personally, I stand bythe claims that I made in my last post and my prognosis that the Yen will depreciate in 2011. I guess it’s going to take more than a ratings downgrade to ignite the correction. Maybe another intervention from the Bank of Japan will get it moving in the opposite direction…but that’s a topic for another day.

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June 30, 2013

Yen Surges to Record High, then Falls on G7 Intervantion. Yen May Rise Further in the Short-term, but Due for a Decline in the Long-term.

Filed under: Japanese Yen — Tags: , , , , , , , , , — admin @ 3:56 pm

The last week has witnessed unprecedented volatility in the Japanese Yen. Following the earthquake/tsunami and the inception of a nuclear crisis, the Yen defied all logic (and embarrassingly, my own predictions…mea culpa) by rising to a post-World War II high of 76.36 against the Dollar. Then, as rumors of Central Bank intervention began to circulate, it suddenly shot downwards, before resuming a steady upward path. Who knows what next week will bring?!

It’s unclear exactly what’s driving the Yen. Personally, it seems a no-brainer that the string of natural disasters that ravaged Japan would have caused an outflow of foreign capital and a drop in demand (due to a lack of supply) for Japanese imports. In reality, investors began to fear a wholesale selling of Japanese-owned foreign securities widespread repatriation of Japanese Yen by insurance companies and other financial institutions, in order to raise funds for rebuilding and the payout of insurance claims.

While there is still no evidence that such has actually taken place (in fact, the Japanese stock market collapsed as expected, and overseas markets experienced only modest declines), speculators feared the worse, and moved to unload all of their Yen short positions. As hedge funds and domestic Japanese investors tried to exit their Yen carry trades, it caused the market to panic, and the Dollar to fall off a cliff against the Yen, rising 3% in a matter of minutes! As if it wasn’t immediately obvious, “Asset managers, hedge funds, corporates and private clients were all net buyers of the yen for the first time since October,” which means that what we’re basically witnessing is really just a massive short squeeze.

As a result of the highly unusual circumstances, the G7 Finance Ministers held an emergency meeting. The decided not only to offer moral support to the Bank of Japan, but that all G7 Central Banks (Fed, ECB, Bank of Canada, Bank of England) would jointly act to hold down the Yen. Sure enough, the Fed confirmed yesterday that it intervened in the forex markets (probably by selling Yen) for the first time in a decade! This marks a massive about-face from 2010, when Japan was uniformly criticized by the G7 for entering the currency war. Desperate times call for desperate measures…

The Yen has since resumed its appreciation, which has a few implications. First of all, it shows that speculators are still nervous about carry trades that are funded by Yen and continue to think of Japan as a safe haven. This is especially true of domestic Japanese investors, who are naturally bound to become more conservative in the wake of the recent natural disasters. No one knows for certain the size of the Yen carry trade, but 2010 estimates pegged it around $1 Trillion. (Japanese investors purchased $1.25 Trillion in foreign assets between 2005 and 2010 alone!) If that’s the case, there is still quite a bit more unwinding that can be done. In addition, given that Japan is the world’s largest net creditor [the Bank of Japan owns $900 Billion in US Treasury securities, while Japanese sovereign debt is 95% owned by domestic investors], the phenomenon of risk-aversion would be net positive for the Yen.

Second, it shows that investors are skeptical that the Yen’s appreciation can be contained. And if market forces are determined to push the Yen upwards, they are probably right. Simply, the G7 Central Banks (not including Japan) have very limited Yen holdings, which means there is only so much Yen they can sell.

On the flipside, the Bank of Japan has potentially an unlimited supply of Yen at its disposal. In fact, the BOJ already expanded its money printing / quantitative easing program, by “doubling planned purchases of exchange-traded funds, real estate investment trusts, corporate debt, and Japanese government bonds to 10 trillion yen, and launching a program to supply financial institutions with 30 trillion yen in three- and six-month loans at 0.1 percent interest.” This is on top of the 28 trillion yen ($346 billion) that is had already injected into the financial system. While perennial deflation has afforded the BOJ a wide scope, it must still tread cautiously, lest it add inflation (and stagflation) to the country’s list of problems.

Some analyst point to the Kobe earthquake of 1995 as a basis for Yen bullishness. After a one-month lull, the Yen dramatically surged upward, rising 20% in only two months. That disaster also took place towards the end of the Japanese fiscal year (March 31), and seems to suggest that a proportionate Yen rise should take place this time, too.

On the other hand, the Yen proceeded to drop 50% in the two years following the Kobe earthquake, showing the extent to which investors had gotten ahead of themselves. In other words, while there might be significant repatriation of Yen in the short-term, this will more than be outweighed by the decline in GDP, collapse in production/exports, and destruction of stock market value over the long-term.

Until the nuclear crisis is resolved and estimates of the cost (currently pegged at $100-200 Billion) of reconstruction are finalized, the markets will remain jittery. And we all know that volatility will not help the Yen carry trade. Given the BOJ’s determination to hold down the Yen, and the fact that this crisis will only exacerbate Japan’s fiscal issues and its unending economic decline, I’m personally still long-term bearish on the Yen.

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June 29, 2013

What’s Next for the Yen? Probably more Decline.

Filed under: Japanese Yen — Tags: , , , , — admin @ 3:56 pm

After the G7 intervened in forex markets last month, the Yen fell dramatically and bearishness spiked in line with my prediction. Over the last week, however, the Yen appears to have bottomed out and is now starting to claw back some its losses. One has to wonder: is the Yen heading back towards record highs or will it peak soon and resume its decline?


Some analysts have ascribed tremendous influence to the G7, since the Yen fell by a whopping 5% following its intervention. From a mathematical standpoint, however, it would be virtually impossible or the G7 to single-handedly depress the Yen. That’s because the Yen holdings of G7 Central Banks are decidedly small. For example, the Fed holds only $14 Billion in Yen-denominated assets (compared to the Bank of Japan’s $800+ Billion in Dollar assets), of which it deployed only $600 million towards the Yen intervention effort. Even if the Bank of Japan is covertly intervened (by printing money and advancing it to other Central Banks), its efforts would still pale in comparison to overall Yen exchanges. Trading in the USD/JPY pair alone accounts for an estimated $570 Billion per day. Thus, given the minuscule amounts in question, it would be unfeasible for the Central Banks alone to move the Yen.

Instead, I think that speculators – which were responsible for the Yen’s spike to begin with – purposefully decided to stack their chips on the side of the G7. Given the unprecedented nature of the intervention, and the resolute way in which it was carried out, it would certainly seem foolish to bet against it in the short-term.  In fact, the consensus is that, “Investors are confident that the G7 won’t let the yen go below 80 versus the dollar again.” Still, this notion implies that if speculators change their minds and are determined to bet on the Yen, the G7 will be virtually powerless to block their efforts.

For now, speculators lack any reason to bet on the Yen. Aside from the persistent financial uncertainty that has buttressed the Yen since the the 2008 credit crisis, almost all other forces are Yen-negative. First, the crisis in Japan has yet to abate, with this week bringing a fresh aftershock and an upgrading of the seriousness of the nuclear situation. The hit to GDP will be significant, and a chunk of stock market equity has been permanently destroyed.


Thus, foreign institutional interest in Yen assets – which initially surged as investors swooped in following the 20% drop in the Nikkei 225 average – has probably peaked. The Bank of Japan will probably continue to flood the markets with Yen, and the government of Japan will need to issue a large amount of debt in order to pay for the rebuilding effort. Given Japan’s already weak fiscal situation, it seems unlikely that it can count on foreign sources of funding.

Even worse for the Yen is that Japanese retail traders (which account for 30% of Yen trading) seem to have shifted to betting against it. They are now driving a revival in the carry trade, prompting the Yen to fall to a one-year low against the Euro (helped by the recent ECB rate hike) and a multi-year low against the Australian Dollar. “Data from the Commodity and Futures Trading Commission (CFTC) showed speculators went net short on the yen for the first time in six weeks and by the biggest margin since May 2010 at a net 43,231 contracts in the week to April 5.”

It’s certainly possible that investors will take profits from the the Yen’s fall, and in fact, the recent correction suggests that this is already taking place. However, the markets will almost certainly remain wary of pushing things too far, lest they trigger another G7 intervention. In this way, Yen weakness should become self-fulfilling, since speculators can short with the confidence that another squeeze is unlikely, and simply sit back and collect interest.

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June 28, 2013

G7 Leads Shift in Forex Reserves. Emerging economies will still favor the dollar but will accumulate fewer reserves than before.

Filed under: Japanese Yen — Tags: , , , , , , , , , , , , — admin @ 3:58 pm

As you can see from the chart below, the world’s foreign exchange reserves (held by central banks) have undergone a veritable explosion over the last decade. While emerging markets (especially China!) have accounted for the majority of this growth, there are indications that this could soon change. China’s reserve accumulation is set to slow, while advanced economies’ reserves are set to increase.


In the past, central banks from advanced economies have accumulated reserves only sparingly, and in fact, much of this growth can be claimed by Japan. This is no mystery. While held by emerging economy central banks, most of the reserves are denominated in advanced economy currencies. This has ensured a plentiful supply of cheap capital, to support both economic expansion and perennial current account deficits (namely in the US!). In addition, advanced economy central bankers tend to hew towards economic orthodoxy, which precludes them from intervening in forex markets, and obviates the need to accumulate forex reserves. Emerging economies, on the other hand, depend principally on exports to drive growth. As a result, many are driven towards holding down their currencies in order to maintain competitiveness. China has taken this to an extreme, by exercising rigid control over the value of the Yuan, and necessitating the accumulation of $3 trillion in foreign exchange reserves.

This trend accelerated in 2010 with the inception of the so-called currency wars (which have not yet abated). Competing primarily with each other, emerging economies bought vast sums of foreign currency in order to promote economic recovery. Many countries from South America and Asia which don’t normally intervene were also drawn in. The result was a tremendous accumulation of foreign exchange reserves, which is reflected in the chart above.

There is already evidence that this phenomenon is starting to reverse itself. Consider first that advanced economies have participated in the currency wars as well. Japan’s reserves have swelled to more than $1.1 Trillion. Switzerland spent $200 Billion defending the Franc, and South Korea has spent more than $300 Billion over the last five years trying to hold down the Won. The Bank of England (BOE) recently announced plans to rebuild its reserves (the majority of which were redeployed towards gilt purchases). The European Central Bank (ECB) has announced similar plans, and may be joined by the Bank of Canada and US Federal Reserve Bank.

Advanced economies need currency reserves for a couple reasons. First of all, they can no longer rely on monetary easing to reduce their exchange rates because of the inflationary side-effects. Second, the recent coordinated intervention on Japan’s behalf showed that the G7 will move to protect its members when need be. Finally, political forces are compelling advanced economies to slow the outflow of jobs and production, and this requires more competitive exchange rates.

Emerging economies, meanwhile, are starting to recognize that unchecked reserve accumulation is neither sustainable nor desirable. First of all, managing those reserves can be tricky. Intervention is not free, and exchange rate and investment losses must be accounted for somewhere. Second, continued intervention has several detrimental byproducts, namely inflation and the handicapping of domestic industry. Finally, emerging economy currency appreciation is inevitable. Constant intervention merely forestalls the inevitable and invites unending speculation and inflows of hot-money.

There are a few of ways that currency investors can position themselves for this change. As emerging market economies stop the accumulation of (or worse, sell off) their reserves, a major source of demand for advanced economy currency will be curtailed. This will accelerate the broad-based appreciation of emerging market currencies against their advanced economy counterparts. At the same time, I’m not sure how much reshuffling we will say in the composition of reserves. The euro is plagued by existential uncertainty, while the yen and pound have serious fiscal problems. In the short-term, the Chinese Yuan is prevented by several factors from becoming a legitimate reserve currency, namely that it is too difficult to obtain. (As soon as this changes, you can bet that emerging economy central banks will begin accumulating it. After all, they are competing with China – not with the US). The dollar is certainly also an “ugly” currency, but given the size of the US economy, the depth of its capital markets, and the liquidity with which the dollar can be traded, it will remain the go-to choice for the immediate future.

In the short-term, traders that wish to short advanced economy currencies (namely the Japanese yen) can do so in the secure knowledge that they are backstopped by the G7 central banks. It’s like you have an automatic put option that limits downside losses. If the Yen falls, you win! If the yen rises, the BOJ & G7 should step in, and at least you won’t lose!

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June 27, 2013

Japanese Yen In “No Man’s Land.” When will the BOJ Intervene to stop its rise?

Filed under: Japanese Yen — Tags: , , , , , — admin @ 3:56 pm

This, according to a hedge fund manager that has decided to cancel all of his fund’s bearish bets on the Japanese Yen. The reason: the yen is rising, and it’s unclear when – or even if – the government will intervene to push it back down. Even though the yen’s strength is fundamentally illogical, it seems that investors are growing increasingly wary of betting against it.


As I pointed out in my previous post on the Yen (“Japanese Yen Strength is Illogical, but Does it Matter?“), the yen has actually fallen over the last twelve months, on a correlation weighted basis (though to be fair, it has staged a pretty impressive comeback since the beginning of April). Unfortunately, investors mainly care about how it is performing against a handful of key currencies, namely the US Dollar. Simply, the yen continues to rise against the dollar, and it is unclear when it will stop.

Japanese government analysis has indeed confirmed that “speculators” are behind the strong yen, as the alleged wide-scale repatriation of yen by Japanese insurance companies has yet to materialize. Of course, there isn’t really much doubt: Japan’s economy is contracting, due to decrease in output spurred by the tsunami. In May, it recorded its second largest monthly trade deficit ever.

Meanwhile, interest rates and bond yields are pathetically low, and the Bank of Japan is being urged to expand its asset buying program, which would theoretically result in a devaluation of the yen. As  a result, retail Japanese forex traders (nicknamed “Mrs. Watanabes“) have resumed shorting the Yen as part of a carry trade strategy.

Alas, speculators either don’t share their pessimism or are running out of patience. While everyone continues to assume that the BOJ will intervene if the Yen rises to 80 against the dollar, no one can be sure whether the line in the sand might not be 78 or even 75. At this point, intervention seems to hinge more on politics than on economics, which means predicting it is beyond the scope of this post. In other words, “There is too much uncertainty and volatility in markets right now to make that yen trade appealing.” And sure enough, the most recent Commitments of Traders data shows that speculators have been re-building their yen long positions over the last month.


In the end, the speculators are probably right. The Bank of Japan has intervened twice over the last twelve months, and the impact has always been short-lived. Besides, given that many speculators still remain committed to shorting the yen, it remains extraordinarily vulnerable to the kind of short squeeze that sent it soaring 5% in a single session en route to the record high it touched in March.

I’m personally still bearish on the yen, but I also think it’s too risky to short it against the dollar, which seems to be declining for its own reasons. As you can see from the chart below, the yen has fallen against virtually every other major currency. Yen shorters, then, might be wise to avoid the dollar altogether and focus instead on any number of other currencies.

http://www.bloomberg.com/news/2011-06-17/japan-recovery-means-boj-can-avoid-adding-stimulus-muto-says.html

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Japanese Yen Strength is Illogical, but Does it Matter? The yen is falling on a composite basis, but rising against the US dollar.

Filed under: Japanese Yen — Tags: , , , , , , , , , — admin @ 3:56 pm

On a correlation-weighted basis, the Japanese Yen has been one of the world’s weakest performing currencies in 2011. Alas, while this information is interesting for theoretical purposes, it is of little concern to traders, who focus instead on individual pairs. Against the dollar (USDJPY), the Japanese yen is still quite strong, having recovered most of the losses inflicted upon it by the coordinated G7 intervention in March. Does the yen deserve such a lofty valuation? No. Will it continue to remain strong as the dollar? Well, that is a different question altogether.

As a fundamental analyst, I am inclined to look at the data before making a determination on whether a particular currency will rise or fall. In this case, the fundamentals underlying the yen are beyond abysmal. The recent release of Q1 GDP showed a 3.7% contraction in GDP. Thanks to an interminable streak of weak growth combined with deflation, Japan’s nominal GDP is incredibly the same as it was in 1996! Based on industrial production, consumption, and other economic indicators – all of which were negatively impacted by the earthquake/tsunami – this trend will undoubtedly continue.

The only force that is keeping Japan’s economy afloat is government spending. While this was a necessary response to anemic growth and natural disaster, it is clearly a double-edged sword. The government’s own (inherently optimistic) forecasts show a budget deficit of 5% in 2015, which doesn’t even include the costs of rebuilding the earthquake region. This will necessitate tax hikes, which will further erode growth, requiring ever more government spending. It seems self-evident that Japan’s national debt will remain the highest in the G7 for the foreseeable future.

From a macro standpoint, there is very little to be gained from investing in Japan. The stock market continues to tank, and bond yields are the lowest in the world. To be fair, years of deflation have made the yen an excellent store of value, but this is hardly of interest to speculator, whose time horizons are usually measured in weeks and months, rather than years and decades.

If not for the yen’s safe haven status, it would and does make an excellent funding currency for the carry trade. Short-term rates are around 0%, and the Bank of Japan (BOJ) has made it clear that this will remain the case at least into 2013. As you can see from the chart above (which mimics a strategy designed to take advantage of interest rate differentials), the carry trade is alive and well. Granted, it has suffered a bit since 2010, due to increased fiscal and financial uncertainty. However, given that the rate gap between high-yielding emerging market currencies and low-yield G7 currencies continues to widen, this strategy should remain viable.

And yet, the Yen continues to rise against the US dollar. It has receded in the last couple weeks, but remains close to the magic level of 80, and it’s not hard to find bullish analysts that expect it to keep rising. They argue that Japanese investors are eschewing risky asset, and that the yen remains an attractive safe haven currency. Not to mention that volatility (aka uncertainty) serves as an effective deterrent to those thinking about shorting it and/or using it as a funding currency for carry trades.

Personally, I’m not so sure that this is the case. If you look at the way the yen has performed against the Swiss Franc, for example, the picture is completely reversed. The Franc has risen 20% against the Yen over the last twelve months, which shows that heads-up, the Yen is hardly the world’s go-to safe haven currency. In addition, you can see from the chart below that on a composite basis, the yen peaked during the height of the financial crisis in 2009, and has since fallen by more than 10%. This shows that its performance in 2011 should be seen as much as dollar weakness as yen strength. Since I’ve spent countless previous posts explaining why I think dollar bearishness is overblown, I won’t revisit that topic here.

In the end, the majority of traders don’t care about this nuance – that the Yen has conformed to fundamental logic and depreciated in the wake of the natural disasters against a basket of currencies – and want to know only whether the yen will rise or fall against the dollar. Even though, I think that shorting the Yen remains an attractive (and as I argued yesterday, comparatively riskless) proposition. Given that the dollar also remains weak, however, traders would be wise to short it against other currencies.

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June 20, 2011

Japanese Yen In “No Man’s Land”

Filed under: Japanese Yen — Tags: , , , — admin @ 4:22 pm

This, according to a hedge fund manager that has decided to cancel all of his fund’s bearish bets on the Japanese Yen. The reason: the yen is rising, and it’s unclear when – or even if – the government will intervene to push it back down. Even though the yen’s strength is fundamentally illogical, it seems that investors are growing increasingly wary of betting against it.


As I pointed out in my previous post on the Yen (“Japanese Yen Strength is Illogical, but Does it Matter?“), the yen has actually fallen over the last twelve months, on a correlation weighted basis (though to be fair, it has staged a pretty impressive comeback since the beginning of April). Unfortunately, investors mainly care about how it is performing against a handful of key currencies, namely the US Dollar. Simply, the yen continues to rise against the dollar, and it is unclear when it will stop.

Japanese government analysis has indeed confirmed that “speculators” are behind the strong yen, as the alleged wide-scale repatriation of yen by Japanese insurance companies has yet to materialize. Of course, there isn’t really much doubt: Japan’s economy is contracting, due to decrease in output spurred by the tsunami. In May, it recorded its second largest monthly trade deficit ever.

Meanwhile, interest rates and bond yields are pathetically low, and the Bank of Japan is being urged to expand its asset buying program, which would theoretically result in a devaluation of the yen. As  a result, retail Japanese forex traders (nicknamed “Mrs. Watanabes“) have resumed shorting the Yen as part of a carry trade strategy.

Alas, speculators either don’t share their pessimism or are running out of patience. While everyone continues to assume that the BOJ will intervene if the Yen rises to 80 against the dollar, no one can be sure whether the line in the sand might not be 78 or even 75. At this point, intervention seems to hinge more on politics than on economics, which means predicting it is beyond the scope of this post. In other words, “There is too much uncertainty and volatility in markets right now to make that yen trade appealing.” And sure enough, the most recent Commitments of Traders data shows that speculators have been re-building their yen long positions over the last month.


In the end, the speculators are probably right. The Bank of Japan has intervened twice over the last twelve months, and the impact has always been short-lived. Besides, given that many speculators still remain committed to shorting the yen, it remains extraordinarily vulnerable to the kind of short squeeze that sent it soaring 5% in a single session en route to the record high it touched in March.

I’m personally still bearish on the yen, but I also think it’s too risky to short it against the dollar, which seems to be declining for its own reasons. As you can see from the chart below, the yen has fallen against virtually every other major currency. Yen shorters, then, might be wise to avoid the dollar altogether and focus instead on any number of other currencies.

http://www.bloomberg.com/news/2011-06-17/japan-recovery-means-boj-can-avoid-adding-stimulus-muto-says.html

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May 22, 2011

Japanese Yen Strength is Illogical, but Does it Matter?

Filed under: Japanese Yen — Tags: , , , — admin @ 3:58 pm

On a correlation-weighted basis, the Japanese Yen has been one of the world’s weakest performing currencies in 2011. Alas, while this information is interesting for theoretical purposes, it is of little concern to traders, who focus instead on individual pairs. Against the dollar (USDJPY), the Japanese yen is still quite strong, having recovered most of the losses inflicted upon it by the coordinated G7 intervention in March. Does the yen deserve such a lofty valuation? No. Will it continue to remain strong as the dollar? Well, that is a different question altogether.

As a fundamental analyst, I am inclined to look at the data before making a determination on whether a particular currency will rise or fall. In this case, the fundamentals underlying the yen are beyond abysmal. The recent release of Q1 GDP showed a 3.7% contraction in GDP. Thanks to an interminable streak of weak growth combined with deflation, Japan’s nominal GDP is incredibly the same as it was in 1996! Based on industrial production, consumption, and other economic indicators – all of which were negatively impacted by the earthquake/tsunami – this trend will undoubtedly continue.

The only force that is keeping Japan’s economy afloat is government spending. While this was a necessary response to anemic growth and natural disaster, it is clearly a double-edged sword. The government’s own (inherently optimistic) forecasts show a budget deficit of 5% in 2015, which doesn’t even include the costs of rebuilding the earthquake region. This will necessitate tax hikes, which will further erode growth, requiring ever more government spending. It seems self-evident that Japan’s national debt will remain the highest in the G7 for the foreseeable future.

From a macro standpoint, there is very little to be gained from investing in Japan. The stock market continues to tank, and bond yields are the lowest in the world. To be fair, years of deflation have made the yen an excellent store of value, but this is hardly of interest to speculator, whose time horizons are usually measured in weeks and months, rather than years and decades.

If not for the yen’s safe haven status, it would and does make an excellent funding currency for the carry trade. Short-term rates are around 0%, and the Bank of Japan (BOJ) has made it clear that this will remain the case at least into 2013. As you can see from the chart above (which mimics a strategy designed to take advantage of interest rate differentials), the carry trade is alive and well. Granted, it has suffered a bit since 2010, due to increased fiscal and financial uncertainty. However, given that the rate gap between high-yielding emerging market currencies and low-yield G7 currencies continues to widen, this strategy should remain viable.

And yet, the Yen continues to rise against the US dollar. It has receded in the last couple weeks, but remains close to the magic level of 80, and it’s not hard to find bullish analysts that expect it to keep rising. They argue that Japanese investors are eschewing risky asset, and that the yen remains an attractive safe haven currency. Not to mention that volatility (aka uncertainty) serves as an effective deterrent to those thinking about shorting it and/or using it as a funding currency for carry trades.

Personally, I’m not so sure that this is the case. If you look at the way the yen has performed against the Swiss Franc, for example, the picture is completely reversed. The Franc has risen 20% against the Yen over the last twelve months, which shows that heads-up, the Yen is hardly the world’s go-to safe haven currency. In addition, you can see from the chart below that on a composite basis, the yen peaked during the height of the financial crisis in 2009, and has since fallen by more than 10%. This shows that its performance in 2011 should be seen as much as dollar weakness as yen strength. Since I’ve spent countless previous posts explaining why I think dollar bearishness is overblown, I won’t revisit that topic here.

In the end, the majority of traders don’t care about this nuance – that the Yen has conformed to fundamental logic and depreciated in the wake of the natural disasters against a basket of currencies – and want to know only whether the yen will rise or fall against the dollar. Even though, I think that shorting the Yen remains an attractive (and as I argued yesterday, comparatively riskless) proposition. Given that the dollar also remains weak, however, traders would be wise to short it against other currencies.

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