Peering Over The Fiscal Cliff, The Yen Gets 'Cheap', Australian Dollar 'Expensive'

Includes: FXA, FXY, UUP
by: Duru

On December 20th, the Bank of Japan rolled out more stimulus and more accomodative monetary policy as expected:

"The Bank decided to increase the total size of the Asset Purchase Program by about 10 trillion yen, from about 91 trillion yen to about 101 trillion yen. The increase in the size of the program corresponds with the size of additional purchases of treasury discount bills (T-Bills) by about 5 trillion yen and Japanese government bonds (JGBS) by about 5 trillion yen (see Attachment 2). Additional purchases of financial assets to be made in the next twelve months under the Asset Purchase Program - inclusive of those purchases that have already been decided - will amount to about 36 trillion yen. In addition, the Bank regularly purchases JGBs at the pace of 21.6 trillion yen per year…

The Stimulating Bank Lending Facility aims to provide long-term funds - up to the amount equivalent to the net increase in lending - at a low interest rate, without any limit, to financial institutions at their request. The Bank decided the operational details of this facility, including its implementation period, which shall be 15 months until end-March 2014… The fund-provisioning under the Stimulating Bank Lending Facility - while it depends on a number of factors - is expected to reach more than 15 trillion yen, based on the recent lending data."

The Bank of Japan is clearly trying to get more aggressive in its efforts to fight deflation and reignite its economy. The effective increase in the availability in Japanese yen may be arriving just in time for what could be a re-ignition of a rapacious appetite for yen as Fiscal Cliff negotiations in the U.S. apparently begin to sour.

Understandably, the yen depreciated significantly going into Thursday's statement on monetary policy.

The recent run against the yen has brought USD/JPY to fresh 20-month highs.

In typical fashion, the market went into "sell the news" mode (by strengthening the yen) in the immediate wake of the BoJ news. However, it was quite telling that the yen quickly reversed after this initial trigger reaction.

The yen swings wildly between headlines

The chart above includes the recent reaction to the news that Republican House Speaker John Boehner failed in his efforts to pass a "Plan B" that would concede tax hikes on millionaires in exchange for deep spending cuts. The failure of this bill created surprise mainly because of the confidence earlier expressed by Boehner and Republican House Majority Leader Eric Cantor that the bill would pass (and effectively pin blame on the Democrats for failing to resolve the Fiscal Cliff). The inability to pass this bill demonstrates that there remains insufficient appetite in the Republican party to compromise on taxes to get a Fiscal Cliff deal done. As long as this remains the reality, the financial markets are now free to start extrapolating the worst outcomes.

The quick rush into yen is likely an early sign of what is to come. The recent run-up has made the yen cheaper than it has been in about 20 months against the U.S. dollar, Australian dollar, and the British pound; a little less against the euro. On a relative basis, these levels make the yen look like a "cheap" place to hide for safety-seekers.

While the yen is likely to strengthen quickly, the Australian dollar looks the most vulnerable to selling. I have already discussed reasons for paring back on bullish positions in the Australian dollar (see "Time To Pare Back Bullish Positions In The Australian Dollar"). Growing Fiscal Cliff worries makes the bullish Australian dollar trade ever more dangerous. The currency has looked like a safety currency, given its resilience in the face of withering rate cuts by the Reserve Bank of Australia (RBA), but its suitability as a safety currency has not been tested by truly bad news. I believe the Australian dollar will fail such a test miserably. As such, I increased my short position even as AUD/USD retests the 50-day moving average (DMA). The Australian dollar has also notably weakened against the euro and British pound over the last 5-6 weeks.

Australian dollar fails perfectly from downtrend line and now retests upward trend of the 50-day moving average.

Source for charts:

Having said all that, I recognize that the Fiscal Cliff is steeped in political gamesmanship, so anything can happen at any time. A positive and encouraging headline could conveniently hit the wires right before trading ends on Friday as traders face down a mad rush to shop for the days remaining until Christmas. All this building negativity could reverse in a flurry. Given those risks, I am NOT reversing course and going long the yen. I am instead waiting for the next opportunity to short it at much better prices.

Be careful out there!

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

Additional disclosure: In forex, I am short AUD/USD