Following on from last week's call to short the AUD, I've turned my attention to the USD/JPY pairing. Since the start of the year, the yen has strengthened significantly against the U.S. dollar, which I believe has opened up the possibility of a trade in favor of the dollar, by shorting the CurrencyShares Japanese Yen Trust ETF (NYSEARCA:FXY).
Why has the Yen strengthened?
During this tumultuous last week, numerous factors contributed to the yen strengthening. China's decision to devalue the renminbi, the Chinese market turmoil, geopolitical tensions between Saudi Arabia and Iran, all meant traders took their money and fled to safe havens.
The Japanese yen is notorious for being a safe haven during troubled times like these, so it is understandable why it has appreciated this week.
What's the opportunity?
Considering the divergent monetary policy outlooks that the U.S. and Japan have, I believe it is only natural that 2016 will see the U.S. dollar strengthen substantially against the yen.
As we are all aware, the Federal Reserve is likely to raise interest rates again in 2016. The act of raising interest rates has a tendency to raise the value of the respective currency, and the opposite generally occurs when interest rates are lowered.
The Bank of Japan is targeting inflation of 2% but, with low oil prices keeping manufacturing cost down, market commentators are speculating that it won't be able to achieve this target. With Bank of Japan Governor Haruhiko Kuroda willing to do whatever it takes to reach this target, many believe the financial markets may increase pressure on the Bank of Japan to initiate additional easing. The effect quantitative easing has on a currency is largely agreed to be negative.
So I believe the net effect of these two superpowers' monetary policies colliding in 2016 should be a stronger U.S. dollar and a weaker Japanese yen.
The average estimate from 28 of the world's leading research firms has the USD/JPY price at 122.23 within 3 months, a 4.2% increase from the last price of 117.26. By the end of 2016, I expect the U.S dollar to have continued to strengthen and expect it to be hitting the 128.0 mark, equating to a return of 9.1%.
I believe that due to divergent monetary policies the U.S. dollar will strengthen significantly against the Japanese yen in 2016 and that going long dollar now would be a good time considering the events of this week.
Shorting the CurrencyShares Japanese Yen Trust ETF is an effective way to play the currencies, and my pick of the FX trades right now. I continue to feel confident that shorting the Japanese yen and Australian dollar will be good plays in 2016.
Disclosure: I/we 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.