Why It's Time to Short the Yen

Apr. 4.11 | About: CurrencyShares Japanese (FXY)

I recently switched my stance on the yen, going from bull to bear. In this post I'll share my rationale for doing so.
First, the fundamental reasons:

1. Japan has a debt problem -- perhaps the largest sovereign debt problem in the world (depending on how one evaluates such problems). One of the main reasons Japan's debt situation has not been an overwhelming problem yet is that the debt is largely domestically owned; in the case of the United States, foreigners own a large amount of the debt. Ultimately, I am not too sure this will save Japan; in my opinion, debt is still debt, and debt that cannot be repaid will not be repaid -- regardless of who owns it. Given the fondness of the Bank of Japan, Japan's central bank, for inflating the money supply, I think a debt default will have an inflationary outcome.

2. The tsunami was obviously a major event -- and one whose effects will likely be felt for some time. In such instances, it may be useful to consider historical precedents. The Great Hanshin earthquake of 1995, affecting primarily the city of Kobe in Japan, resulted in a sharp strengthening of the yen immediately for a few months -- but then a sharp decline over the next three years. The chart below illustrates.

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We recently had a hammer on the monthly chart, after a downtrend, after a natural disaster. Could we be setting up for a repeat here? The chart below shows the current situation.

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I found this trade to be a bit appealing because I thought it had a good risk/reward ratio; if we reach new lows in USDJPY, it will be time to take a small loss. But if the Yen is going to default in an inflationary manner, USDJPY could really soar to new heights. In light of these factors, I decided a small long USDJPY position would be worth taking.

Disclosure: I am short FXY.