Recent Bounce Is A Good Opportunity To Short The Yen

| About: CurrencyShares Japanese (FXY)


FXY has the highest recent relative strength of all CurrencyShares.

Japan has the highest Debt/GDP ratio on the planet.

Japan's re-militarization is going to worsen an already dire budget situation.

Aren't CurrencyShares great? The historical complexity of investing in foreign exchange rates has been boiled down, at least for nine major currencies, into a simple ETF trade.

At the same time, CurrencyShares are sort of a bummer. The reality is, none of the ten currencies has much of an interest rate in this day and age, with the Australian dollar (NYSEARCA:FXA) the only one that even cracks 1%, while four of the nine currencies actually have negative interest rates.

Still, it's a decent way to spread out your currency exposure, and with options in play, there are also opportunities to jump in on trends and play the overall movements in exchange rates.

Looking East
Today's a little different for me, because while I'm usually looking for bargains on the long side, the numbers here are telling me the real opportunity may well be a short, and in this case, on the Japanese Yen (NYSEARCA:FXY).

FXY Chart

FXY data by YCharts

As you can see, the yen has seen a very healthy rise throughout the past 12 months, and people who bought at the bottom have enjoyed an extremely nice return. Indeed, a quick look at the 14-day relative strength also shows the yen as the strongest of the CurrencyShares. So why are we shorting?

The numbers
Since this isn't the 19th century, and our exchange rates don't boil down to the relative weights of different precious metals, we have to dig a bit to value currencies. An awful lot of their value rests in public perception, with foreign currency reserves also playing a role. More than anything though, what we need to look at is economic growth and national debt.

GDP Growth Budget Deficit Debt/GDP
FXA 2.5% (2.1%) 44.3%
FXB 2.2% (4.5%) 90.8%
FXC 1.2% (1.9%) 95.4%
FXCH 6.9% (2.6%) 16.7%
FXE 1.9% (3.0%) 86.8%
FXY 0.5% (6.5%) 227.9%
FXSG 2.0% (0.5%) 111.4%
FXS 4.1% (1.1%) 44.0%
FXF 0.9% 0.2% 34.0%
US$ 2.4% (2.4%) 73.6%
Click to enlarge

Source: CIA World Factbook

By all three of those reckonings, the yen is the weakest, and in most cases dramatically so. Their debt as a percentage of GDP is not just the largest of the 10 countries' currencies listed above, but indeed the largest of all active currencies, with the Zimbabwe Dollar a close second.

To make matters worse, Japan is running the biggest budget deficit on the list, again by a fairly wide margin, and has the slowest growing economy, meaning they're less able to grow their way out of it.

All of that is important because a developed nation's real lender of last resort is the currency itself. When the national debt gets too big, and interest rates on it start to rise, the nation's central bank can print more money to make up the difference. If one country is printing money much faster than the others, their currency weakens.

Re-militarization: Another expense
Japan's budget deficit is bad enough as it is, but the Abe government's plan to re-militarize adds another potentially major expense at a time when the nation can least afford it.

In September, parliament authorized Abe's plan end a nearly 70 year ban on overseas military operations. Though presented by the government as a very limited shirt, military officials insisted that in practice it would mean there is almost nothing their nation's military couldn't legally do.

US officials have been very supportive of the idea, seeing a resurgent Japanese military as a potential ally in overseas operations, but after generations of formal pacifism, the Japanese military isn't equipped or prepared for such operations.

That's going to mean more spending, particularly on the equipment that would facilitate such operations, and Abe's own designs on being prepared to counter China over maritime disputes threatens to add a substantial naval expense on top of it.

The planned re-militarization has faced significant protests, but the Abe government has gone ahead, despite the fairly obvious deleterious impact on the budget deficit. All of that is very bad news for the yen.

Japan has managed so far to keep its bond yields low, and that's kept a lid on things for the time being. How long they can continue to expand their already massive national debt, when their economy isn't growing at a pace to keep up with it, remains to be seen.

In the long run, however, the numbers don't lie. The yen is in a much worse position than any other major currency, and combined with the recent run-up that makes shorting FXY over the long-term a very good play. Whether that means simple shorting, or buying puts, is an exercise best left to the reader, and based on their personal risk threshold. For my money, the Jan 2018 90.00 puts are very appealing.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in FXY over the next 72 hours.

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.