Japanese Yen Poised to Renew 1995 High

Standard & Poor’s says the worst is almost over in terms of structured credit losses for the big banks. If that is so, why did the New York Fed take the extraordinary step of directly providing liquidity to Bear Stearns (BSC) through JPMorgan (JPM)? S&P’s estimate of $285 billion in losses is still way below the $400 billion in losses estimated by a US Monetary Policy Forum Draft of February 2008, and substantially below the $1 trillion estimate by Noriel Roubini of Global EconoMonitor fame.

We believe the S&P report does not fully consider the implications of a general unwinding of leverage in the whole financial system. According to Bank of International Settlement’s estimates of OTC derivatives versus the underlying securities upon which these derivatives are based, leverage in the financial system is nearly 12X, which is close to the 12-fold leverage estimated by the Policy Forum Draft. Moreover, the International Swaps and Derivatives Association [ISDA] numbers indicate leverage of more like 250 times the collateral put up for these derivatives. There is also significant leverage in Fannie Mae (FNM) and Freddie Mac’s (FRE) portfolios, as both have an equity base of only $71 billion versus owned or guaranteed mortgages worth some US$5 trillion.

In breaking up through JPY100/USD, the JPY has staged a classic “cup and handle” break-out to the upside, which we believe strongly implies a challenge of historical highs at least in terms of the USD. Given a crashing USD, the JPY has spurted above JPY100 for the first time since 1995, when the Yen hit an historical high of JPY79.75/USD. However, the yen may not stay on this pinnacle for long. In 1995, it began to depreciate almost immediately after peaking and crashed to the JPY140/USD level during the Russian default crisis in August 1998, some three years later.

During the last run in the yen past JPY100/USD in 1995, essentially all sectors of the Japan Topix fell, and the Topix as a whole was down some 30% from 1994 highs to 1995 lows. Consequently, the best strategy for investors to take is to de-leverage as much as possible, keep cash positions high, stay invested in commodities, and wait for the storm to pass.

Comments

[Thomas Kase:]

Good piece!

See also: finance.yahoo.com/q/bc...=

I have dealt with Japan since ’90 – and this kind of currency move is just not ‘right’ – trade btw the US and Japan is far too established to justify this rapid change. Last time it happened (’95) this quickly there was a massive correction – as you point out – which has whacked Japan’s economy for about 10 years.

Neither country is seeing rapid growth, so is this the results of ‘their’ de-investing in the US, hedging against the dollar, and stocking up on oil futures? Election year issues?

2008 Mar 17 09:08 AM

[Darrel Whitten:]

Thomas;

Its a perfect storm in the currency markets too.

1) The yen carry has unwound as hedge funds blow up,
2) Sovereign Wealth Funds like Qatar which were 99% in USD two years ago are now down to 40% USD exposure,
3) "Bad boy" oil exporters like Iran and Venequela are now asking Japan to pay them in JPY instead of USD
4) US pension funds like CalPERs are reducing USD equities and shifting funds to international bonds, equities away from USD assets.

Ironically, individual Japanese investors are again loading up on USD and other foreign exchange investments on the assumption that the current blow-out in the Yen in will not last long.

2008 Mar 18 12:44 AM