Comparing Apples And Oranges: U.S. Dollar And Japanese Yen

Includes: FXY, UDN, UUP
by: Cerebro1

I can never agree to the idiom "Comparing apples and oranges". Both are fruits, sweet, similar in size, weight & shape and both are grown in orchards. There are actually two studies, one published in the Annals of Improbable Research as well as the British Medical Journal, which concluded that apples should be compared with oranges. Notwithstanding this, people still use the idiom.

Some may also contend that based on the products and services exported, demographics and other economic factors; the U.S. dollar (USD) and the Japanese yen (JPY) are comparable to the idiom. However, when focusing on the policies of the Fed and the Bank of Japan (BOJ), investors can benefit from neglecting the idiom. Furthermore, based on the progress of the Fed's and BOJ's policies, investors can benefit from a position in (NYSEARCA:FXY).

It is expected that USDJPY will decline approximately 9.33% from current levels, risking a 3.23% move against this premise. This is a risk/reward ratio of 1:2.89. The decline will take USDJPY to around the 88.45 price level and to the 109.70 price level.

USD Apples

The U.S. is in its 5th year of the QE programme whereby the Fed is purchasing U.S. Treasuries and MBS to keep yields low and asset prices stable. Currently the Fed is purchasing US$85Bn a month in these securities. The effects of the QE programme appear to be adhering to the law of diminishing returns. Latest figures show that U.S. GDP grew at a 1.6% pace year over year for the second quarter of 2013, and the Fed's PCE Price Index grew 1.2% year over year, below the Fed's 2% target rate. While the unemployment rate has been improving, it is still above the Fed's 7% threshold. The illustration below shows the Economic Projections of the FOMC as at September 2013.

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Like the JPY-oranges, the USD-apples weakened during the QE measures. The chart below shows the daily chart of the Dollar Index (DXY).

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DXY is currently in a downward trend channel. While the Index may find support around the 79.50 level, a move upwards from these levels appears to be corrective. DXY may find resistance around the 81.75 price level. Investors seeking to benefit from this should consider purchasing (NYSEARCA:UUP) when DXY is around the 79.50 level with a 0.42% stop below the entry price. Investors are also cautioned to exit this position when DXY reaches 81.75. From this point investors should consider shorting DXY or purchasing (NYSEARCA:UDN).

JPY Oranges

The QE policy tree appears to be bearing similar fruits in both the U.S. and Japan. However, this season the Japanese orange appears much sweeter. It is almost a year since the Japanese elected Shinzo Abe, who appointed Governor Haruhiko Kuroda. This administration adopted a very aggressive QE programme where the BOJ's monetary base is expected to increase at an annual pace of 60 to 70 trillion Yen. The asset purchases are segregated into Japanese government bonds (50 trillion yen), ETFs & J-REITS (30 billion yen) and CPs and Corporate bonds (2.2 trillion yen and 3.2 trillion yen respectively). The policy appears to be successful thus far with Japanese GDP year over year increasing back above 1%. Latest figures show Japan's second quarter GDP year over year growth is at 1.2%. The chart below shows Japan's GDP year over year.

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The pickup in Japanese inflation has been remarkable. After spending over a year in negative territory, Japanese CPI is now at 0.9% year over year for September 2013. If conditions remain the same or even improves marginally, the BOJ should meet its inflation target within 6 months. The chart below shows Japan's CPI.

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Comparing Apples & Oranges

With both the Fed and BOJ enforcing their QE policies, it is more or less a race to the bottom for both the USD and the JPY; the apple and the orange. Investors should monitor the current policy stance of both central banks to determine which fruit will ripen first. Given the current momentum in the Japanese economy it appears that the BOJ's 2% inflation target will be met before the Fed's 2% target and 7.0% unemployment threshold. Furthermore it should be stated that the Fed's metrics are thresholds, not triggers, so the central bank is unlikely to immediately tighten as these measures are met. Thus investors may unwind their short JPY positions before their short USD positions. Readers can take advantage of this.

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Technically, in the medium term, JPY is already positioned to strengthen against the USD. The chart above shows USDJPY with weekly candlesticks. The symmetrical triangle pattern appears to be in play as the candle closed below the weekly blue support trend line. For this move to bear some fruit investors can purchase , risking 3.23% (a price move above the red resistance trend line) for a return of 9.33% (a target for the completion of the symmetrical triangle which is the difference between the apex and base from the breaking of the support trend line). This trade carries a risk/reward ratio of 1:2.89.

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.