Currency ETFs: What Does the Yen's 10%+ Drop Tell Us?

The flight-to-safety play in 2008 didn't include gold. In fact, it was mostly concentrated in U.S. treasuries, the U.S. dollar and the Japanese yen.

In 2009, however, both gold and the dollar have climbed. Why the U.S. dollar continues to perform well is a bit of a mystery to those who have predicted its destruction. With trillions upon trillions of debt and the printing presses seemingly rolling non-stop, it does seem strange that the world's most established currency is still hanging onto its reign.

In contrast, the Japanese yen is down more than 10% since it peaked mid-December of last year. The yen has actually fallen below the levels seen at the height of credit anxiety during the October and November low points.

The primary ETF for yen investors is the CurrencyShares Japanese Yen Trust (FXY) shown in the chart below. This ETF has already dropped substantially below its 50-day moving average. However the yen would have to drop another 2.5% in value or more to fall below its longer-term, 200-day trendline.

With stock markets all but scraping new February lows clear across the world, why is the yen struggling? In recent memory, the yen typically rose with risk aversion... as it did at the start of the "collapse" in mid-September of last year. One can see that, at that time, the CurrencyShares Japanese Yen Trust (FXY) climbed above its 200-day moving average. (Is the yen now looking to trend in the other direction?)

Japan is more dependent on its exports for economic success than nearly any other nation. The global recession and the strengthening of Japan's currency has made it terribly difficult for its multinationals to sell products to the world. The weaker the yen, the better their exports fare... but the stronger the yen, the more trouble Japan faces.

That's why Japan's leaders have been desperately seeking ways to weaken the yen. Perhaps the Japanese government is having some success with policy. Or, possibly, investors are beginning to take more risk with their money again.

Curiously, if policy direction is succeeding, then one might expect the iShares MSCI Japan Fund (EWJ) to perform better than it has. After all, the weaker yen would boost the prospects for the Sonys (SNE) and Toyotas (TM) in the index. Nevertheless, we're seeing Japanese equities fall to new lows in February, much as we've seen in the U.S.

So if the yen is falling because there's greater risk appetite, why aren't we seeing stocks respond? It's likely that the risk being taken is far more incremental; that is, investors are returning to high-grade corporate bonds, but they haven't been willing to go further out on the risk tree limb. (Some of that money may be going into hedges and hot money like gold too!)

Beneficiaries may possibly include the iSharesIntermediate Credit Bond Fund (CIU), the Treasury Inflation-Protected Securities Fund (TIP) and a number of individual bonds as well. For example, Toyota Motor Credit Corp has an A-rated issue with a 6% coupon that's trading above par at 102. This offering goes out to 2021 with a 5.8% yield-to maturity.

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.

Comments

[morph366:]

I suspect that the Bank of Japan are steering their currency down in a bid to boost exports, which as you suggest, is the lifeblood of the Japanese economy.

Feb 26 08:12 AM

[Tom E.:]

They recently gave $100 billion to the IMF. If they gave in Yen and told them to convert it to dollars, that would weaken the Yen.

Feb 26 09:40 AM

[Mad Hedge F...:]

There is a lot of talk today about the recent weakness of the yen, which along with gold, became the focus of the “short America” trade. The Japanese currency has backed off from its ¥88 peak a month ago to ¥98, breaking several key technical levels, and seems poised to go lower. Other than flight to safety, there was never a reason to go long of this currency. The trade and current account surpluses are in free fall as Toyotas, Lexus’s, Hondas, and Infinitis pile up on west coast docks. The economy is even sicker than ours, and with zero interest rates for the past 14 years, this certainly is nobody’s yield play. Clearly the yen became the global carry trade’s cheap date, and the cross has emerged a highly sensitive indicator of global risk taking appetite. Could this bout of weakness be a mustard seed of economic recovery, a light at the end of the tunnel? Watch the Proshares Ultra Short Yen ETF (YCS), which gives you a 200% short play, and is up 25% in a month

Feb 26 01:04 PM

[HaavBline:]

Yen's strength has been powered by the rewinding of the Yen Carry trade by Japanese retail investors. By year end 2008, if is clear that rewinding was near completion. That the strength of the Yen will bring big trouble to the export-dependent Japanese real economy is no big surprise, and shouldn't cause both the FXI and EWJ to decline together, as the author theorized.

The new risk factor that has begun to catch investors' attention is in Japanese politics. The Liberal Democratic Party which esscentially governed Japan for more than 50 years seemed finally doomed to loss the mandate to govern later this year. On the one hand, LDP is deemly unpopular, on the other hand, the Japanese, one of the most insecured people in the world, are deemly worry about the uncharted political future of a two-party system (finally after 60 years the US gave them a democratic constitution)

The drunk Finance Minister video certainly brought everybody to the realization how incompetent the LDP has become.

Feb 26 11:52 PM