There are numerous reasons to be short the yen. Japan has a demographic problem; a slumping economy seemingly headed for another recession; a record high debt to GDP ratio; and recently, a trade deficit caused in part by the elevated level of the yen. There are other fundamental reasons to be bearish on the Japanese economy, but we are focusing on currencies here, and the most important fundamental affecting the relative value of a currency is the flow of money.
Money flows can be caused by longer-term capital investments, by current international trade balances, or by the attitude of the currency speculators. Forex trades are not visible, so it is difficult to get a feel for the speculators preferences. Currency futures markets, however, do offer a some visibility, and in the yen, it is now quite interesting.
Today's report from the Chicago Mercantile Exchange, for futures trade alone without the delta adjusted options, shows the open interest is now about 215K contracts. Yesterday, the OI went up by 7,122 contracts. The OI in the yen now exceeds the OI in the euro. Granted, yesterday's trade in the yen was only 112k, compared to 235K in the euro, but the build in the OI tells us the yen is getting loaded up with spec shorts.
How do we know the new players are spec shorts? The last COT report showed that the total net spec short in the yen was 96.3K contracts. The increase in the OI since the release of the last report tells us new specs are piling in on the short side. Had the OI gone down, this would have told us the specs were getting out of the market.
There is another way to measure the popularity of trading the yen. After the expiration of the four futures trading months in the currencies, we look at the amount of OI remaining. In September 2012, 127K contracts of the yen remained open. This compared to 226K contracts of the euro left open.
The rapid expansion of the OI tells us there is an abundance of traders with new positions. Certainly, there are myriad factors bearish on the yen, but how much is already priced into the market, and how will the market act if the bearish news does not continue?
I am looking at the new Forex Razor economic calendar, scheduled to be released to the public next week, and count 13 Japanese reports scheduled to be released in the next 12 hours. Most of the estimates are negative, but again, are they priced into the market?
Since the market is loaded with shorts, we do not wish to join the party at this time. Perhaps there will be some selling as we approach the end of trading in the December contract. We also want to watch the relationship of the yen to the A$. Should the RBA reduce the money rate next week, weakening the A$, and we get some buying in the yen, we will consider buying the AUDJPY (FXA, FXY) on a sell-off, perhaps around the 84 handle. We will be watching this trade, hoping to find the appropriate entry level.