The newly elected Japanese Prime Minister, Shinzo Abe, has been actively talking down the value of the yen. Part of his election campaign was to increase the supply of the yen. This would then end years of deflation. Instead, he would target inflation to increase by 2% per year. Like ECB President Mario Draghi, who used words to scare the bond vigilantes, Abe has successfully talked the yen lower. The result has been strength in the USD versus the JPY from around 79 to above 88.
The rapid USD appreciation moved the 14 day RSI above 87 -- rare altitude for any market. During the last three trading sessions, the USD has backed off from the top. Is this a market reversal, and a major sell-off is coming, or is this a head fake, and the retracement is a buying opportunity?
Later this week, Japan's Finance Minister, Aso, will unveil the latest stimulus plans. The rumors are there will be a stimulus package of up to ¥20T. Details are unclear, but the supplementary budget will include ¥5T for public works spending, and ¥2.6T to cover shortfalls in the national pension scheme. They also claim they will use some of their currency reserves to buy European bailout or ESM bonds.
Will this be government action to please the yen bears? According to our last COT report, speculators were short 122.9K contracts, a very large net short. True, the futures represent only a small portion of the yen trade. The cash forex is a bigger market, and there are likely many short yen and long Australian and Canadian dollars, as well as other currencies. But after a move of this magnitude, the yen bears may get uneasy if further yen depreciation plans are not quickly introduced.
Buying the yen (FXY) versus the sale of something would certainly be a contrarian trade, but trends do end. Traders take profits and move on. But what to sell against the yen?
Today in The Telegraph, Jeremy Warner had an interesting story: "Sterling crises looms as UK current account deficit balloons." He says:
"With fears of a eurozone break-up, a calamitous fiscal contraction in the U.S., and a hard landing in China now fast receding, it is possible financial markets will refocus their attentions on more conventional concerns. The failings of the UK economy might be prime among them.
Some of the reasons for this need little explanation. Low growth has undermined attempts to reduce the fiscal deficit, which remains one of the highest in the OECD. This in turn is likely to lead to the loss of Britain's prized triple A credit rating this year, making the UK comparatively less attractive to overseas investors. What's more, capital flows from the eurozone to perceived "safe havens" such as the UK are slowing as the crisis eases. There is also evidence of elevated concern among investors about Bank of England money printing.
But some of the other reasons are less well appreciated, possibly because we've become so accustomed to them. Almost unbelievably, Britain has not enjoyed a trade surplus in goods since 1981, or more than 30 years ago. This long-standing weakness has been partially compensated for by a relatively large surplus on services, and on overseas income, but even so, Britain has been in overall current account deficit ever since the mid-1980s."
It has been the flow of capital into the UK that has covered the trade deficit. A calmer eurozone may result in a weaker pound (FXB). Speculators though, according to the recent COT report, are long the pound by about a 2 to 1 ratio. If we are to sell the pound and buy the yen, we are taking the contrarian side of both currencies.
The move in the pound versus the yen has been huge. In the middle of November, it was trading at under 126. The bull run in the pound then took it to almost 1.43 on January 2nd. This market has since slipped under 140. The market acts like it has made a top. If you try the short side, a trade above the 14210 would not be good. A little downside momentum, however, might take the pair back to the 133 handle.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.