At long last the Japanese yen's rally against the U.S. dollar (NYSEARCA:UUP) came to an abrupt halt. The question now, though, is whether this is a temporary blip on the road to further strengthening or the start of something bigger. For a long time we have been hoping for some weakening from the yen, and for a long time we have been disappointed to find none forthcoming.
But on Friday the Japanese yen dropped after reports surfaced about the Bank of Japan considering offering banks negative rates on some loans. Essentially, paying the banks for taking the money. Furthermore, it is widely believed that the central bank may also cut its negative rates even further when it meets this week.
But is this the start of greater falls this week?
Being short the yen versus the U.S. dollar we are of course very hopeful that it is. But the truth is the timing of the decline is a little odd. Everybody knew there was a strong chance the Bank of Japan was going to act aggressively at its next meeting as it simply has no choice but doing so. The yen is out of control and the country will never be able to make its inflation targets. But hedge funds are currently the most bullish on the yen since records began in 1992, so it seems they expect the yen to strengthen still.
It is possible that hedge funds were anticipating further easing through the form of asset buying, but have been caught out now with rate cuts seemingly the preferred easing method. If there is a mass exodus, the selling pressure could drive the yen lower. But one thing we have learnt is to never expect anything but the unexpected from the yen. The rise of negative interest rates around the world and the Fed's failure to raise rates has currencies behaving in unpredictable ways.
Long-term weakening is more certain.
So whilst we are hopeful and reasonably confident that the yen will depreciate against the U.S. dollar this week, we are not about to bet the house on it. But those with long time horizons certainly could look at betting the house against a weaker yen in the future, though. We feel certain of substantial declines eventually from the yen.
When Janet Yellen and the Fed start to raise rates we expect the U.S. dollar will strengthen against all major currencies. At this week's FOMC meeting it is incredibly unlikely that rates will be raised. The market does not appear to be pricing any chance of a rise into the market, but there is a lot of speculation that there may be hints at a rate rise next month.
One rate may not be enough to bring down the yen greatly, but any sign of a pathway to periodic rate rises should give cause for confidence in the dollar to return and perhaps a sign to exit the yen.
The Bank of Japan meanwhile will do their part at their own meeting after the Fed meet. Adding negative rates to its lending to banks is the first step. A further cut to its existing negative rates would be the next step. This should start to make the currency unattractive and depreciate it further, in theory.
The big week ahead.
It will be a big week ahead for the USD/JPY pair that's for sure, and we have little doubt that there will be a lot of movement.
Sourced from tradingeconomics.com
Three key data releases within the space of eight hours will see to that. The Fed's interest rate decision will be closely scrutinised not for the decision, which will almost certainly stay the same, but for the rhetoric in its statement.
Following this we have Japanese inflation some five and a half hours later. A bad reading here may cause the yen to drop substantially, leading many to fear strong action from the Bank of Japan at its interest rate decision two and a half hours later.
Sourced from DailyFX
We see the U.S. dollar climbing to 114 yen by the end of the week if the central bank actions mirror what we have discussed today. This would be representative of a 2.6 percent increase from the current trading price for the pair, but only the beginning of long term gains.
Our long-term target for the dollar is to climb to 125 yen by the end of the year. We are confident this will happen if and when the Fed starts raising rates. We feel the economy is strong enough to cope with at least two rate rises this year, and hope to see this being the case. 125 yen is 12.6 percent higher than where it trades now, making it a lucrative trade.
Shorting the yen via the CurrencyShares Japanese Yen Trust ETF (NYSEARCA:FXY) is possibly the best way to go about this if you, like us, feel confident enough in the strengthening of the U.S. dollar against the yen.
A warning though. The FX markets are incredibly unpredictable currently thanks partly to negative rates. The Bank of Japan has struggled to control its currency so far this year, so there is nothing to say that the latest action will work. But, we feel the slight decline on the reports of the latest plans it may take, could be a hint that things are finally changing. One thing for sure, though, is that by the end of the week we will certainly know more.
Best of luck with your trades!
Disclosure: I am/we are short FXY.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.