For weeks the forex markets have been focused on the plight of the euro and the economies in the eurozone. The bears were perplexed, as the euro versus the U.S. dollar continued to find support around the 1.30 handle. We suspected, as did other analysts, that there was clandestine buying, perhaps from the Chinese, around this level. Finally on Monday the 7th of May, the market opened with a gap lower, and was unable to muster the strength to fill the gap. Technically this unfilled gap was a bearish sign and the market support then seemed to melt away.
This sell off, so far, took us to a low of 1.2681 this morning, but has since bounced back up above the 1.2750 area. With the 14 day RSI drifting down below 25, the pair has been under a lot of pressure, and clearly in oversold territory.
A currency's value is judged by its relationship to another currency or commodity. For weeks the euro has been sold against the USD as well as other currencies. The perceived safety of the mature Japanese economy and the yen has made that destination a safe haven for the nervous holders of cash, or other currencies vs. a low of 83.30 against the USD on the first trading day in April, the yen appreciated to 79.43, where it has met some resistance, and subsequently weakened against the dollar to 80.40.
The strength in the yen has been contrary to the wishes of the Japanese government and the Bank of Japan. The strong currency, combined with damage caused by last year's natural disasters, has resulted in the first Japanese trade deficit in many years. With the specific intention of weakening the yen, and spurring some inflation, the BOJ has increased the yen supply and kept interest rates very low.
Looking at the collective positions of yen specs in the futures markets, we find they have had mixed judgement at market turns. When the market started to weaken in early February, prodded by the BOJ, they were long 49K contracts. By the middle of March when the yen had weakened to 84 and change, they were short about 84K. In early April when the market became more alarmed about the euro plight, specs were short over 104K contracts. As the yen firmed they remained short, but did take their position down to 71K.
There are a number of long-term reasons we favor a short yen position. Interest rates are low, and they are going to stay that way. The demography does not favor growth for Japan. Their population is aging and not being replenished. They are switching away from nuclear to another more costly energy which must be imported. China, Japan's largest trading partner, has a slowing economy. Japan needs a weakened yen to stimulate exports. Finally they have the largest sovereign debt to GDP ratio of any developed country.
Recent work on the daily chart shows a saucer bottom. If we break out of the pattern, a recovery should take the USD/JPY back to the 82.80 level. To achieve such a rally, we need to take the pressure off of the euro. There are rumors, perhaps wishes, the Germans are going to bail out the Greeks one more time, but there are also stories of bank runs in Athens. These markets provide big opportunities and risks. It is best to watch the developments closely.
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