The Nikkei 225 And The Japanese Yen: How Long And How Far Can This Pair Move In Opposite Directions?

| About: CurrencyShares Japanese (FXY)

It seems like we have a winner. Asian Development Bank President Haruhiko Kuroda has emerged as the leading candidate for the post of Bank of Japan's next governor.

Kuroda is a supporter of aggressive monetary stimulus measures that Japanese Prime Minister Shinzo Abe advocates, making him an ideal candidate for the government. He also has an extensive international network in the financial world that, combined with his English proficiency, makes him a potentially suitable "ambassador" to deliver the Japanese monetary policy to the world. Apparently, the Japanese authorities expect that there will be much to explain over the next couple of months… As such, Mr. Kuroda's highly regarded diplomatic skills may play a crucial role in his candidacy. From Abe's point of view, he is definitely "the complete package".

Bank of Japan's current governor Masaaki Shirakawa and his two deputies are set to step down on 19 March. Abe is expected to take a final decision on the next candidate as early as next week, in consultation with the Finance Minister Taro Aso.

Other candidates for the race include ex-financial bureaucrat Toshiro Muto and former economist to the governor and deputy governor of BOJ Kazumasa Iwata. Earlier this week, Reuters had reported that Toshiro Muto was the favorite to take up the post next. Mr. Iwata suffered a major downbeat after the Japanese Finance Minister's statement following the recent G-20 meeting, In his statement Taro Aso said that Japan won t form a soveriegn fund in order to buy foreign bonds. This idea was very much led by Mr. Iwata and, therefore, the odds of him being elected next BoJ governor shrank immediately. Apparently, you don't wish to stand up in Abe's monetary very bullish ambitions these days, especially not if you are a candidate for a senior financial position.

Mr. Muto, on the other hand, is still considered a strong candidate due to the support he is getting from the powerful Aso. Unlike the case of Mr. Iwata, Mr. Muto hasn't clashed rhetorically with Prime Minister Abe's monetary statements, at least not recently, and therefore he wasn't disqualified… yet.

According to a separate Reuters report, Kuroda had made aggressive interventions in the exchange rate markets to weaken the yen as a top financial diplomat between 1999 and 2003. If selected as the next BoJ chief, it would force him to cut short his term as ADB chief.

Nevertheless, the appointment of Kuroda is not decisive yet. The final call on the candidate has to receive the approval of both houses of the parliament. Since Abe's Liberal Democratic Party does not hold majority in the upper house, he will have to look for opposition support.

One of the main tasks is to avoid repeating the embarrassment that occurred in 2008. Back then, both candidates for the BoJ governor were rejected by the parliament because they were perceived as too dangerous for the BoJ independence.

Interestingly, one of the candidates rejected in 2008 was Mr. Muto, who is now trying his luck again. It's very likely that history is going to repeat itself.

Speculations on the next central bank chief had, to some extent, weighed on financial market sentiments, as the decision could prove crucial to Japan's recent efforts at an economic recovery. Nonetheless, the themes we have witnessed over the last couple of months - a rising stock market and declining currency - remain intact.

It's clear that the government will be looking for a dovish governor, who would accommodate stimulus demands. And the "dovisher" - the better!

The equity market clearly likes and expects Mr. Kuroda to be appointed. The Nikkei 225 rose 2.5% today and the Japanese Yen crashed from 93.3 to 94.8 (although since reaching this multi-year high it strengthen back to sub-94 levels).

Declaring Mr. Kuroda as the next BoJ governor would most probably give a boost to this ongoing trend - higher equity market and lower JPY.

While I can see the JPY contnuing to weaken - there's not much the world can do against Mr. Abe loud and clear intentions - I doubt that the equity market can move up further for too long. Fundamentals of the Japanese economy as well as of Japanese corporates are so weak that one may wonder how long the Nikkei 225 can go up based solely on the external factor (JPY weakness) while ignoring the internal factors (weak underlyings).


While keeping a short position in the Japanese Yen for the longer term, through shorting the FXY or JYN, I find it dangerous to stick to long positions in the Nikkei 225 for too long.

If you are long EWJ or DXJ I strongly suggest you follow these positions closely and protect yourself with stop-loss limits because the trend is a friend only as long as it's not dead.

Final thought about the Japanese Yen

We are all aware that the JPY has a "safe haven" status. In case of a mega-event or major crisis anywhere around the world that involves greater fear or higher level of uncertainty, the JPY tend to strengthen. Bear this in mind and remember that we, investors, should always expect the unexpected. Unexpected events will occur; it's just a matter of time and magnitude.

When the tsunami hit Japan back in March 11th 2011, the JPY strengthened significantly over the course of the following days. I found it very strange then and the "repatriation of monies" explanations seem more like the tail wagging the dog.

I always ask myself: What does it take for the JPY to weaken as a result of a worldwide major crisis? What type of mega event will break the equation: higher uncertainty = stronger JPY?

Well, here is a philosophical question for you in that regard:

What will happen if Japan as a whole would cease to exist? Would the JPY strengthen in such an event?

I doubt it - even foolishness has its limits - but the truth is I wouldn't be surprised if it does.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I'm currently, temporarily, holding no position in favor or against the JPY although my long-term view is bearish and over most of the last couple of months I'd been shorting the JPY.