he Japanese are hoping to restart the their nuclear plants this week. If the restart goes well, this will make a significant reduction in their imports of low sulphur fuel oil used to produce energy. Since Fukushima, their use rose to a maximum of over 150,000 barrels per day before they were able to convert some of the energy sources to coal and natural gas. During the peak fuel oil use period, Japanese became the largest consumer of low sulphur oil in Asia.
Japanese energy import costs have soared since the Fukushima accident. Priced in $US at a time when the yen has been plunging, this has weighed on the balance of trade. The November deficit was the biggest for that month, $US 5.73B in the last 30 years. Going forward Japan expects these energy costs to decline.
The US Trade balances and those in Australia beat expectations. In the US it remained a deficit but it was down $34B from the expected $40B and last months $39.3B. Likewise the Australian trade balance, though a deficit, did beat the expectations. Taken alone these factors might have resulted in a lower yen, but such was not the case, probably because the market is loaded with shorts.
Looking at the COT report, there is already a near record short position in the yen. The report from January 7th shows the specs to be net short 172,903 contracts. Many times bearish news does not always bring lower markets when the trade is already overloaded on the bear side.
It appears, the market had already discounted the bear news. The failure of the market to sell off, in this case a higher USD, prompted liquidation. The following day, the CME open interest report showed over five thousand contracts liquidated, as the USD retreated to under 103.
The popularity of the short yen trade rests on some longer term considerations. Japanese debt is already 240% of the GDP, a level PM Abe may increase with his plans for more spending. Further the large monthly bond purchases which has resulted in weakening of the yen, is to continue.
Most of the Japanese debt is financed internally, but the Japanese ten year bond is yielding under.70% compared to much higher years elsewhere. This will hasten the movement of Japanese investment capital to move overseas. Chances are the trade, hidden the global FX trade of over $5T is already happening as the money moves to higher yielding bonds in Europe, the US and Australia.
Specs have also been super bearish on the Australian Dollar (AUDUSD, FXA, FXY, AUDJPN) versus the USD at reported by the CME. In the latest report specs are short 71.9K contracts of the Aussie. This is a very large position in a market where the total open interest is only 140K. Much of the bearishness in the A$ may be because the economic difficulties in China, their biggest trading partner are severe.
Again the specs are short and the A$ is expected to weaken. So we have two big long term bearish trades open Recently there has been minor corrections in these trends but nothing is really disturbed. In a fashion short sellers in the AUD may consider this is a proxy, and the Chinese situation will continue to weigh on the Aussie. We,however, think this bet, shorting the AUD, a proxy for the deteriorating Chinese economy, would be far less harmful to the AUD, than some of the possible negative outcomes of the Abe experiments.
Demography is another factor that favors Australia over Japan. The aging Japanese population is a problem, especially when combined with a low fecundity rate and a society that does not permit immigration. Compare this with the Australian approach. There they encourage immigration for those with education and skills.
Also, there is positive growth projected in both Japan and Australia. This week the World Bank estimated the 2014 growth rate in Japan to be 1.4%. In Australia the growth rate estimated by the Reserve Bank is 3.0%. It is curious to see the weakness in these two currencies against the euro when the projected growth in Europe for 2014 is only 1.1%, up from -0.4, in 2013.
We prefer to buy the AUD and sell the JPY, This might be analogous to buying the least ugly of the two, but in the longer term we suspect the Aussie may have be more attractive. Since October 2013, this pair has been stuck in a trading range , 92 to 94. We wish to buy the AUDJPY toward the lower part of this range, and patiently wait to see if the Japanese economy is really like the proverbial " bug looking for a window."