Dysfunctional Euro Finance Ministers Send Currency Traders To Seek Safe Havens

Includes: FXA, FXY, UUP
by: Ralph Shell

Once again the European Finance Ministers met to address the Greek debt situation. The €31.5B tranche originally scheduled to provide bail-out funds in June has yet to be dispersed. While the hapless Greeks legislate more austerity, the debt-to-GDP ratio is expected to increase to 190% next year, well in excess of the 120% target set by the IMF.

The problem is the IMF and EU austerity plans do not work. They shrink the economy. As a result, the Greece GDP is down 20/25% over the past four years, tax receipts have diminished, the debt remains and the economic death spiral continues.

Clearly debt forgiveness is needed if Greece is to survive but the problem is private-sector debt has been written off, and all that remains is ECB, and IMF guaranteed debt. Neither ECB President Draghi nor IMF director Lagarde want to take the loss. Doling out another tranche of funds that are unlikely to be repaid is unnerving to all concerned. It is also sending currency traders scurrying off to seek havens elsewhere.

Recently the USD had strengthened versus the yen, going from the 78.50 area to an 80.67 high on November 2. This move appears to have been prompted by spec selling when the Bank of Japan vowed it was going to increase the yen supply. According to the COT reports, the spec short position increased from 1,776 contracts on October 9, to 84,948 contracts in the latest reports.

From the USD high versus the yen, 80.67, the yen then gained to under 79.50. We do not know the composition of the buying. Perhaps it was spec short covering or perhaps haven buying in the yen. The Japanese economic news remains negative and it is our preference to remain a yen seller.

The yen has been quite strong since 2008. During this period, Japanese wages have increased by 63%. This combination of a strong currency and higher wages has been a killer for Japanese industries. Sony and Sharp, big names in electronics, are fighting for survival. Panasonic forecasts a $9.6B loss for the year because of a soft market and a strong yen.

Twenty years ago Japanese exports accounted for 10% of the world's total. Now they account for 5% and are diminishing, as is the Japanese trade surplus.

The economic news released from Tokyo this week was grim. The quarterly GDP, annualized, plunged to a negative 3.5%. The soft global economic conditions make it likely the current quarter will also be negative. If so, this will be the fifth Japanese recession in the last 15 years.

Like other developed nations, the debt in Japan is soaring. The Japanese government debt hit a record high of $12.4T at the end of September. This makes the debt-to-GDP ratio over 230%.

With the current rates in Japan of .10% for two-year paper, and .74% for 10-year bonds, financing costs are not high, and most of the debt is financed internally. However the low rates in Japan, and BOJ assurance they will remain low, make the yen attractive as a funding currency.

Consider going long the AUD versus the JPY in the 82.40 area. (FXA, FXY, AUD/JPY). It sounds like the new Chinese officials will try to give the economy a boost, which may help the Aussie. Besides the bank rate there is 3.25% compared with practically nothing in Japan.

Against the USD, it looks like there should be some support in the 78.90 to 79.30 area, but there may be more uncertainty in that pair. How will the approaching "fiscal cliff" influence the markets? Some say it is so bearish on the economy it is bullish on the USD as a haven. That sounds illogical to me but who knows? There are some peculiar things going on. As always, mind your money.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.