At present the dollar bulls may be in control, but in yen translation, the bear has awoken from its slumber as the greenback acquaints itself once again with the coveted ¥100 handle this week. Experienced investors have taken their time revisiting this familiar territory for many reasons. If not for geopolitical or event risk topping the yen's barrier list to medium-term weakness, it was probably the deathly quiet trading month of August that silenced capital markets to the point of near paralysis that pushed traders to the sidelines.
With seasonality excuses all but forgotten, both the EUR and USD bulls are now within striking distance of last May's yen lows. The danger here is that too many market participants are holding the same position and thinking the same thing. Investors are banking on a lot of reckoning. Is Prime Minister Shinzo Abe's proposed consumption tax a fait accompli? Current yen pricing appears to presume so as investors gamble on Japan's economic growth being strong enough to support the tiered tax that is to be implemented next April. Abe is expected to announce a supplementary budget when the tax is formally introduced to Japanese taxpayers on Oct. 1.
The country's economy is steady at the moment, and raising the tax as planned from 5% to 8% in April 2014 and by 10% in October 2015 are important steps for the Abe government to take toward sustainability, as it attempts to lower Japan's crippling national debt. Aside from 15 years of deflation, Japan's debt is the most frightening among industrialized countries, sitting at more than twice the size of the Japanese economy. The markets, along with the prime minister's critics within his own party, will have to wait and see if the sales tax hikes will help to slow the country's consumption rate. Frustrating Abe is the fact he has limited options. On the flip side, failing to increase Japan's sales tax could lead overseas investors who have been happily benefiting from the tenets of Abenomics to unload their Japanese assets at a gradual pace.
To be clear, the potential tax increase has nil to do with deflation. Deflation remains a monetary phenomenon that Bank of Japan Governor Haruhiko Kuroda continues to wrestle with. The Bank has committed to buying about 70% of planned bond issuances from the world's most heavily indebted nation in an attempt to achieve Abe's 2% inflation rate target within two years.
For now, the yen bears, dominated by Japanese pension funds, can bask in the glory of a potential repeat of yen-funded trades, supported by an easing of U.S. credit even in the face of next week's potential Federal Open Market Committee "taper lite" announcement. Extending the 2009 (¥100.10) dollar highs is very doable medium term as long as the mayhem in Syria continues to recede. The weakest yen bears' biggest short-term fear is neither fundamental nor political, but technical. The market is predominately leaning one way, and that's looking for a higher dollar. Thus, any dollar resistance will only put pressure on the weakest of the yen shorts until the market can get a clear picture from the U.S. Federal Reserve.