The aftermath of the global financial crisis provided investors with a new opportunity in the USD. With the Fed reducing the Fed's funds rate to 0% and implementing QE, investors used those policy measures to borrow in USD rather than the already low-borrowing cost yen, shuffling the carry trade. This shift was one of the factors to the strengthening of the yen versus the USD as investors unwound their carry-trade yen-positions into USD. Now, as the Japanese took a more aggressive accommodative policy stance and the Fed is deliberating the tapering of QE and raise its benchmark rate, investors switched back from borrowing in USD to yen. The major benefactor of this shuffle to and fro is USDJPY. Investors contemplating a long USDJPY position should consider shorting the ETF (FXY) or purchasing the ETF (YCS). In determining when the music for the shuffle has started investors should first identify the current economic positions of both the U.S. and Japan as well as the policy actions of their respective central banks.
THE USD CARD
Economic data from the U.S. has been positive but momentum appears to be stalling. U.S. GDP for the first and second quarter of 2013 has been growing, but below 1.5% year over year. The charts below shows U.S. GDP as well as the Fed's GDP forecast.
Chart 1: U.S. GDP % YoY
U.S. inflation has also been tepid, with U.S. CPI averaging 1.73% over the past 3 months and 2% in July 2013. Furthermore the PCE Price Index, the Fed's inflation metric has been below the Fed's 2% target since April 2012. The charts below shows U.S. CPI as well as the PCE forecast.
Chart 3: U.S. CPI %Yoy
The labour market has been improving, with the latest figures indicating that the unemployment rate is 7.4%, the lowest rate since the crisis. The chart below shows the U.S. unemployment rate.
Chart 4: U.S. Unemployment Rate %
After observing the data it appears somewhat difficult to conclude that the Fed should unwind or taper its QE programme or even raise the Fed's funds rate. The only data point that appears to be within the Fed's forecast is the unemployment rate, which is 0.4% above the Fed's threshold. Assuming a fourth quarter pickup in economic activity to above 2% in GDP, the Fed is more likely to taper in December 2013/January 2014 rather than in September 2013.
THE JPY CARD
The Japanese economy has been improving, with second quarter 2013 GDP at 0.9% year over year, higher than the 0.3% first quarter figure. However, growth was below economists' forecasts. The chart below shows Japan's GDP.
Chart 5: Japan GDP % YoY
Inflation, on the other hand, appears to be moving towards the BOJ's target. After remaining negative since May 2012, Japan's CPI posted 0.2% year over year in June 2013. There is still room for Japanese CPI to improve as the BOJ's target is 2%. The chart below illustrates Japan's CPI.
Chart 6: Japan CPI % YoY
Japanese policymakers appear hesitant to increase any stimulative measures in the short term given the relatively positive economic data. They prefer to monitor the economic data given that they have already stimulated the economy earlier this year. The QE programme from Kuroda's BOJ can be attributed to the recent yen weakness versus the USD and is the primary factor for the return of the yen carry trade. USDJPY is up over 10% YTD. The preference to pause and monitor the economic situation has also touched Japanese fiscal policies. Abe's administration seems to be prepared to postpone corporate tax increases until the target growth and inflation metrics are met.
PLEASE DON'T STOP THE MUSIC
The data from the U.S. and Japan suggests that the Fed will not taper in the short term (0 to 3 months) and the BOJ will not increase its QE programme in the short term. Also historical USDJPY prices propose that USDJPY has the potential to decline to the 86.50 level, if the head and shoulders pattern complete. The Chart below is the Weekly USDJPY chart.
Hence investors should wait for the following triggers before shuffling from borrowing in USD to borrowing in yen or shorting or purchasing.
- Fed tapering announcement [expected December 2013]
- BOJ/Abe stimulus announcement [expected between Q4 2013 and Q2 2014]
- USDJPY holds at 95 [the head and shoulders pattern fails and UDJPY resumes uptrend]
- USDJPY breaks below 95 and trades around the 86.50 level [ head and shoulders pattern completes]