During the past week the yen was strengthening slightly against the dollar and substantially against the euro and other currencies. The yen is perceived as a safe heaven currency and investors flock to it during times of stress and anguish. In the 2008 crash the yen strengthened against the dollar substantially from 115 to 90 yen/dollar. A move of over 20% in a year. So the intuitive trade for crash periods (currently we are in such a period) is to buy yen.
This time it might be different.
Longer term trends that point to a weakening yen:
1. Exports - Japanese exporters will not be able to bear any more pain – the current level of yen are hurting Japanese exporters, and are difficult to sustain. Other currencies are becoming cheaper while the yen is becoming more expensive. This will hurt Japanese companies that are increasingly turning to move production out of Japan. Nissan's (OTCPK:NSANY) Chief Executive Carlos Ghosn last week warned that Japanese car makers may be forced into a major strategic rethink if the yen stays near its recent record highs.
2. Trade Deficit - Japan has turned a trade surplus to a trade deficit in 2011. This was caused by a number of reasons: the tsunami, gas prices and the yen. The tsunami hurt imports and exports, but in August exports grew again, albeit slowly and slower than imports. The world slowdown effects the deficit positively by reducing fuel prices, thus reducing imports. On the other hand demand for Japanese exports falls and as a result exports decrease. It seems that the general trends are lower surpluses and more deficits for Japan.
3. Debt - Japan boasts the largest debt to GDP ratio in the developing world. This debt is internal and held by the people of Japan. Even so it is huge and returning it seems virtually impossible. An aging population and a related slowing in the saving pool will make it increasingly difficult for Japan to finance itself in the future.
Short term reasons to short Yen:
1. Japanese central bank intervention – The Japanese central bank is fully aware of the implications of the strong yen. It is being pressurized by corporate and politics to intervene. It has clearly stated that if the rate continues to decrease it will intervene, and in the past it has intervened at around the 76 yen to dollar rate.
2. The Swiss successful Intervention – The Swiss franc which is also conceived as a flight to safety currency gained substantially during the past few years and especially during 2011. Recently the Swiss central bank capped the rate of Euro/CHF, thus aggressively intervening to keep a bottom to that franc/euro exchange rate. As a result the Swiss franc weakened substantially. The Japanese are surely standing on the side looking at the Swiss experiment and contemplating their next move.
Shorting the yen and going long dollar at this stage seems like a relatively low risk play with high profit possibility. Even if the yen strengthens it is not probable that it will strengthen substantially without the BOJ intervening in the market. On the other hand there is a lot of room for the yen to depreciate against the U.S. dollar.
Disclosure: I am long YCS.