Yen Breaks to the Downside

Includes: FXY, JYF, JYN, UUP
by: Ralph Shell

In an article written earlier this month, observing the increasingly narrow trading range of the USDJPY, we wondered when and which direction the pair would move. The initial move to the top side proved to be a head fake. On July 7th and 8th the U.S. dollar gained on the yen, trading up to the topside of the BB, above 81.40, and then failed.

This week the yen has gained on the U.S. dollar, trading at 78.46, before returning above the 79 level. The strength of the yen has expanded the trading range, eliciting a concerned response from FM Noda as reported in Reuters today:

"Japanese Finance Minister Yoshihiko Noda warned on Thursday that recent yen strength does not reflect economic fundamentals, escalating a verbal campaign to cool the rising yen although traders saw little immediate chance that authorities would intervene directly in the market.

"The movement doesn't reflect fundamentals and has been one-sided," Noda told reporters on Thursday regarding the yen's recent surge.

"It would be troublesome if it persists, and I will continue to closely watch markets."

Whether this anti strong yen chatter will result in anything more than appeasement of the Japanese export trade remains to be determined. But there are some reasons to think that central bank intervention is unlikely. The rebuilding effort from the damage caused by the March 11 disaster is expensive, and requires sizable imports. Further, electricity formerly fueled by nuclear power is now being replaced by imports, primarily oil. With oil and many other products prices in U.S. dollars, a stronger yen is beneficial.

The yen may also be making friends because Japanese fiscal problems are more deferred than those in the U.S. and Europe. The IMF warns that the Japanese debt to GDP is among the highest in the world, forecast to reach 250% of GDP by 2015. Of more immediate importance is failure to find a solution to the eurozone debt problems and the U.S. squabble over extension of the debt ceiling. It appears this concern about the U.S. dollar and the euro has driven some of the safe haven buyers to the yen as well as the SF.

For central bank intervention in the currency markets to be effective, a coordinated approach of numerous banks works best. Currently the difficulties confronting the U.S. and European Central Bankers are many. We doubt, then, concern about a marginally stronger yen will rank very high on the bankers "things to do" list.

This week's strong performance by the yen has been accompanied by a build in the futures open interest, about 20%. This means there are a significant number of new yen players, probably specs getting long. The 80 handle was support, and should now be resistance. If this market settles back close to 80, we want to be a seller of the USDJPY. It would not surprise us if the U.S. dollar worked down toward the 76 level, taunting FM Noda and PM Kan. As always, watch you stops, and or consider a protective option position.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.