ASO Short Yen - Nope, That's The Problem

by: Dean Popplewell

The market has been selectively quiet in Europe as investors wait for Q4 U.S. earnings results to shepherd them, to where is yet unknown. Investors continue to have concerns over the health of the U.S. economy. Politicians persistently debate ways to cut spending and elevate their own country’s borrowing limit. One moment currency risk is taking its cue from a positive move in global equities, the next; risk aversion is dominating and has the lemming yen bears beginning to scramble.

Is the astute investor contemplating hunkering down, expecting a southbound equity correction to occur over the coming months due to the ongoing budgetary battle in Washington? If nothing else, expect the professional news service “sensational” reporting to say it’s so.

In Japan, the BoJ and anyone else who can garner airtime has a yen position to debate. The USD/JPY bandwagon so far has been consistent. The currency from "the rising sun" has plunged -12.6% since the end of last September. Many forecasters expect the Japanese currency to remain low for the remainder of this year, bidding adieu around the 88.0 mark in Q4. The outright pair has taken a northbound flight for good reasons, but are they good enough reasons?

The yen has fallen on tough times due to the expectations of a more aggressive monetary policy; a pre-Christmas Shinzo Abe political promise. Prime Minister Abe has called on the BoJ to tackle deflation by raising its inflation target. Last night, the Japanese Finance Minister Taro Aso indicated that Japan will buy bonds issued by the European Stability Mechanism (ESM) to help weaken the yen, and that the bond transactions will be funded by the country’s foreign exchange reserves. The aforementioned efforts have a primary role of a weakening a domestic currency and reasons enough to support the lemming short yen portfolio positions. Are we sure we are not in the midst of a currency war?

The hope that with the U.S. recovery underway, it may lead to the possibility that the Fed may not be wholly committed to extending QE purchases (forgoing a looser monetary policy) has also been supporting the "big dollar" outright to yen. Even with global risk sentiment becoming less of an issue, dollar and yen rate differentials are expected to favor the greenback.


However, there are a few loopholes in the "weaker" yen argument that the dollar buyer should be aware of. Given that the Japanese monetary policy is already accommodative, a new CPI or inflation target may not have a commanding impact. Fixed income traders are quick to enlighten the masses that the spread between the U.S. and Japanese rates, which has up until now been a reliable guide for dollar direction, is struggling to widen. U.S. yields need to aggressively rally to sustain any upwardly momentum for the mighty buck against yen.

It was slightly confusing to watch the EUR/JPY somewhat maintain its rally last night, especially after the Japanese Finance Minister's statement that ESM bond-buying is to be funded by their foreign reserves. Any purchases financed by a pool of existing reserves will not have a weakening effect on the Japanese exchange rate. Yen bears should understand that already having a pool of available funds means no sale of yen is involved!

The major technical problem with this trade is that too many investors “have it on their books.” Already this year, the dollar/yen pair has managed to print a 29-month high. The declining of global tensions is capable of making the yen unattractive and many bears more concerned. Optimism over the eurozone debt crisis may be misplaced. Euro-politicians still struggle to produce a sustainable solution. For now, it’s just not news worthy enough. These are good enough reasons not to marry this one directional trade with gusto!

Forex heatmap