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It’s the Bank of Japan versus the Rest of the World

It’s the Bank of Japan versus the Rest of the World

2016-02-13 00:10:00
James Stanley, Currency Strategist
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It’s the Bank of Japan versus the Rest of the WorldIt’s the Bank of Japan versus the Rest of the World

Fundamental Forecast for Yen:Bullish

It’s been quite the week for the Yen, and taking a step back, it’s been quite the two-week stretch for the Japanese currency. Two weeks ago, the Bank of Japan made the surprise move to negative rates. This was shocking: Few saw this coming, and even fewer know what all this might entail. In the week after this move, we began to get an idea. While the design of negative rates is to get excess reserves from banks that are on deposit at the Central Bank, the actual reaction has been one more of fear than anything else. Yen weakness did not follow like the BoJ was likely looking for, and instead we’ve seen massive strength.

This week is when matters appeared to have come undone. Rampant Yen strength throughout the week leading into Thursday morning made it look as though a full-fledged run on the currency was about to take place. While the Yen strengthened by 3.75% against the US Dollar last week, by Thursday morning this week’s tally was already up to 4.97%. And then, all of a sudden at 7:19 AM (ET), the Yen dropped like it had been hit with an anvil. This lasted for about three minutes and saw USD/JPY trade from 111.39 all the way up to 113.68. This was a 2% range in less than three minutes.

The prevailing thought at the time, and this was even reported by some of the more popular financial blogs was that this was the Bank of Japan intervening as they felt a run on the Yen coming on. This couldn’t be confirmed, and the BoJ gave a ‘no comment’ on the matter. So, that still remains for debate. But deductively speaking, there isn’t much out there that can create such a strong and wide-spread move in a currency in such a short period of time. So this is a factor that we may have to contend with moving forward.

Nonetheless, the Bank of Japan has been down this road before. They’ve been warned by the G7 set of nations against artificially weakening their currency simply to prop up their exports. This happened in February of 2013 just as ‘Abe-nomics’ was beginning to fire up the Japanese economy. And as my colleague Kristian Kerr points out, they’re probably going to want to avoid any obvious and overt, heavy-handed intervention considering that there is a G20 meeting at the end of this month.

The other factor of consideration is China: China was closed this week in observance of Lunar New Year while global markets were showing significant signs of weakness, and last weekend, Chinese Foreign Reserves showed another massive capital outflow in January. As China continues to face headwinds, more and more capital is likely going to run out of the country, and that’s going to need a place to go. And in Japan, those negative rates are only imposed on bank deposits at the Central Bank, and they haven’t yet filtered down to individual deposit holders. So, for Chinese residents, the idea of keeping cash in a Japanese bank account at no yield while China continues to face headwinds could be a really attractive investment option.

This just puts even more pressure on the Bank of Japan, and that makes the likelihood of additional intervention from current levels less likely. Moving forward we’re adjusting the forecast for the Yen to bullish, but just like last week – one must pick their spots. This theme of Yen strength on the back of continued risk aversion could be especially attractive against US Dollars, British Pounds, Australian and New Zealand Dollars, or in any cross synthetic paired up with an emerging market currency like the South African Rand or the Mexican Peso. To create such a synthetic cross, a trader can match up equally sized (and equal risk) setups in USD/JPY and then in USD/ZAR, or in USD/JPY and again in USD/MXN. The goal would be to offset the US Dollar risk in each pair, and instead focus the exposure on short Pesos or Rand against Long Yen. So, by going short USD/JPY and long USD/ZAR, the trader would effectively be exposed to short ZAR/JPY.

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