Yen Continues To Pale In Comparison To The Mighty Dollar

Includes: FXY, UUP
by: FX Analyst


Strong showing of the USDJPY so far driven by the stellar U.S. Non Farm Payroll in November and bullish Fed speech. Market expectation of hawkish FOMC meeting in December 2014.

3 possible scenarios of Japanese Election which leans towards weak yen. Only if Abe loses the election, will we see a strong yen.

Ideal for investors to go long the USDJPY or short the FXY.

I have urged readers to consider the long USDJPY trade on this article, Go Long The USDJPY Before Japan's Snap Election that was published on 30 November 2014. The next possible date to take action was on the 01 December 2014 when the market opened on Monday.

Source: FXCM

If we take the closing price of 118.38 as reference, the USDJPY would have gone up 29.14% to the high of 121.83 today on 08 December 2014. Hopefully readers have been able to profit from this movement.

This move has been aided by the strong US Non-Farm Payroll results on 04 December 2014. The non agricultural sector in the United States has added 321,000 employees in November on a net basis together with a 0.4% wage growth. This is over the consensus of 231,000 and this came together with an upwards revision of 29,000 employees in October to 243,000

Source: Forex Factory

A glance at the chart will tell you that this 321,000 reading has not been surpassed in 4 years. The last time we had such a strong reading was in May 2010 with 431,000 due to temporary census hiring of 411,000 workers or a net gain of 390,000 government workers. From 2011 onwards, there was a sustained improvement in the labor market and we did not see any negative readings. The worst was no growth in September 2011 and from then on it is a question of how well the economy can recover.

This strong reading in November 2014 is responsible for the big jump from the opening price 119.77 to the closing price of 121.42 in a single day. This is a significant 165 pips (or +13.78%) movement and it is above the average true range upper limit of 142 pips.

So it is not surprising that the market retraced today on the next trading day as you can see in the chart above even on the daily chart. However the long USDJPY trade still remains valid as this is a technical retracement. There are no major items on the economic calendar that will drive the Japanese yen until the election itself on 14 December 2014.

As for the US, the next major economic outlook is the retail sales and core retail sales on 11 December and producer price index (PPI) and core PPI on 12 December itself. However the most important US event will be next week on 17 December 2014. The Federal Open Market Committee (FOMC) meeting statement will be released. We note that this meeting comes before the PPI and the strong employment reading. The 0.4% wage growth is notable as it will influence the FOMC towards a more hawkish statement. This is after the bullish speech from 2 key members of the FOMC, Vice Chair Stanley Fischer and New York Fed President William Dudley last week.

They have regarded the low energy prices as temporary which will not hinder their decision to tighten monetary conditions. They view this tightening as necessary as the economic recovery is on track and the recent data should support this outlook. In other words, the market would continue to price in a more hawkish FOMC until next week itself gradually.

As for the Japan election, there can only be 3 outcomes. First it is that Abe wins a 2/3rds super majority in the Diet. This will be bullish on the yen on a very short term as Abe gets a clear mandate to implement his Abenomics. However given the strength of the USD, it is likely to be short-lived as the market would then focus on this implementation and more importantly signs that the implementation is having the intended policy prescription of reviving the economy. This will take time and Japan will have to suffer through the uncertainty associated with the second consumption tax hike.

The second outcome is that Abe wins a majority but less than his existing seats in the Diet. This would be a likely scenario in my opinion. This is because even if the opposition is unable to feed into the public insecurity of the state of the economy, this would show itself in the course of the election and erode Abe's support. This would mean that Abe would have to delay the implementation of the tax hike. In addition, Moody's recent downgrade of Japanese Government Bond (JGB) from A1 to Aa3 will weigh on public sentiment and this kind of election result would trigger a higher risk of downgrade from Standard and Poor. In this scenario, the possibility that Japan will emerge stronger is much lesser.

The last scenario is that Abe loses the government again. This is not very likely but the most damaging to Japan. The debate last week has shown that the 7 opposition leaders do not have a better plan to counter Abenomics. Being politicians who are elected on the pain of Abenomics, the first casualty would be the Bank of Japan (BoJ) Governor Kuroda Haruhiko. The second casualty would be the 80 Trillion yen monetary accommodation program. This will definitely caused the yen to strengthen and the JGB market to drop sharply as the BoJ stops its purchase. We do not even have to wait until Kuroda is removed from his post. The election result itself will trigger this market assumption.

Then again this is not a high possibility scenario given the disarray of the opposition. In the first 2 scenarios, the yen will continue its weakness with episodes of strength as market expectations gets ahead of itself. I would expect greater volatility as the election draws near but in the meantime, we can still profit from the long USDJPY trade at a proper entry price. The retracement is not likely to last long, so by the time you read this, it is likely that the bullish trend has reasserted itself provided of course that there is no negative shock to the market.

Finally for traders who want to avoid the leverage inherent in forex or for investors who wish to hedge against the weak yen, the ideal instrument to do so would be the CurrencyShares Japanese Yen Trust ETF (NYSE:FXY). The FXY tracks the strength of the yen and it is listed on the New York Stock Exchange and denominated in USD.

Source: Stockcharts

The bearish trend is clear and it is likely to continue. It is also highly correlated to the USDJPY. Hence the FXY is a good ETF to short.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.