A Week of Wonder and Befuddlement for the Yen
Fundamental Forecast for Yen:Neutral
- USD/JPY Outlook Clouded with Bearish Pattern Ahead of Fed Testimony.
- The Bank of Japan’s move to negative rates has brought currency themes back into the spotlight, and one of the primary contentions that major economies will have to deal with will be trade flows.
- Positioning still remains stretched to the up-side of USD/JPY, and given the contrarian nature of such an observation, this could lead to further weakness in USD/JPY spot rates.
Last week we looked at the astonishing surprise decision by the Bank of Japan to move to negative interest rates. This was so utterly surprising because of all of the economies in the world that are facing pressure right now, Japan wouldn’t be near the bottom of the list. More pressing issues are taking place in China and Europe where weaker currencies aren’t just a preference, but almost a requirement if those economies are to ever begin recovering. And if those economies continue their downward descent, well we’re all in for a bumpy ride; regardless of which economy you’re a part of. This made the Yen an extremely viable candidate for safe-haven flows, as capital really only has so many places to go and through simple deduction Japan looked like a fairly prime landing spot.
This, of course, carries risk for Japan. Yen weakness is one of the few aspects of Abe-nomics that’s actually worked as planned, and Japanese companies enjoyed a huge boon when the Yen weakened off by ~60% against USD in a little under three years. Think about what this means to a Japanese company? If you’re selling goods in the United States at the same price today as you were 3 years ago, you’re bringing back approximately 60% more Yen; from a simple currency movement. You didn’t have to do anything different, you didn’t have to develop new products or innovate in any special ways, no; you just had to not mess up and allow the currency markets to do the heavy lifting for you.
Unfortunately this is a zero-sum game with some fairly nasty repercussions. This weaker Yen means Japanese auto manufacturers can lower their prices and still produce a tidy profit (this is where deflation becomes a risk as prices fall). This means American auto manufacturers will sell fewer cars. So, sure, a weaker Yen is good for Japan, but not so great for not-Japan. And keep in mind – for much of this three-year reign of Yen-weakness on the back of Abe-nomics, China was pegging the Yuan to the Dollar. So, by deduction the Yuan strengthened massively against the Yen as well. China is nearly tied with the US as Japan’s top trade partner. So, this hit of Yen weakness from 2012-2015 was a direct shot to the economic trajectories of both the United States and China. This is likely a contributing factor to current issues still developing in Mainland China.
This is why currency devaluations have the ugly implication of being a ‘beggar thy neighbor’ strategy. You’re benefit is at the cost of someone else; and those costs can have consequences. This is just another reason that move to negative rates was so surprising. With much of the global economy ailing, Japan made an aggressive move in a rather surprising manner.
But as we said last week, negative rates are still a very ‘new’ thing in markets. The ECB has used them, but that’s been in concert with the concurrent announcement of a fairly large QE program, so we still don’t’ know how negative rates will work in isolation. This is all still very new. By many accounts, negative rates in Europe haven’t ‘worked.’ The design of negative rates is to spur lending by charging banks for keeping deposits at the Central Bank. Instead, negative rates in Europe meant banks simply sent that capital into other Central Banks through American or Japanese branches that actually paid interest; and now with Japan going negative, the sole outlier is the United States.
The one aspect that we can remark upon at this juncture is that the Yen weakness that was sparked last week came to an abrupt end. Amazingly, USD/JPY is already trading below the pre-announcement price. So the logical statement can be made at this point that Japan going negative only increased the prospect of risk aversion as investors have continued to buy the Yen anyways.
Also, a huge hat tip to both Jamie Saettele and Kristian Kerr. I linked both of those articles last week in the talking points, but both of these gentlemen were sitting on the offer and just waiting to fade this move in USD/JPY. Jamie was warning of a 26-year trend-line and Kristian was doing what Kristian does (in-depth timing analysis centered on the concept of Pi and price analysis around Phi (Fibonacci)). It took me a day to find a setup, but eventually a technical formation set-in against the Euro that allowed for a short-side setup.
Despite the profitable pull that long-Yen positions produced this week, we’re reiterating our neutral stance on the Yen for the simple fact that negative rates are still such a gigantic question mark. It’s obvious that Kuroda wants a weaker Yen, but the bigger question is how far the rest of the world will let him take it. On the Yen, you’re going to have to pick your spots, and technical analysis can be really helpful here as it can assist with risk management.
The data front next week is extremely light and it’s the Lunar New Year in China, so much of Asia will be closed on Monday with Mainland China on holiday for the entire week. We do get Chinese FX reserve numbers on Sunday, and that’s becoming an increasingly important data point as the rest of the world tries to determine how aggressively slowdown is hitting the Mainland.
In terms of specific Japanese data, we get trade numbers on Sunday and PPI on Wednesday. PPI could be especially market moving as it will allude to current inflationary forces in Japan, but given the fact that this move to negative rates was made after much of this data had already been collected, we’ll likely continue to see a greater pull for/against the Yen with the larger overall themes of risk aversion.
From the US, we get Humphrey Hawkins. This is the twice-a-year testimony of Ms. Yellen in front of Congress. This could be big if she mentions anything new, but given the Fed’s pattern of stability expressed throughout this week, it doesn’t seem likely that she’ll use that opportunity to drop any major bombshells or surprises. This testimony could certainly hasten the development of or assist in the rescission of these themes of risk aversion.
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