Currency speculators are at "maximum bullishness": bullish bets on the Japanese yen (NYSEARCA:FXY) have reached levels unseen since at least 2009.
2016 has seen a rapid accumulation of net longs on the Japanese yen. Speculators have not been this bullish since at least 2009.
Source: Oanda's CFTC's Commitments of Traders
Facing off against this bullishness is the Bank of Japan (BoJ). The rapid appreciation in the Japanese yen threatens the BoJ's efforts to hit its inflation targets and shepherd GDP growth. Coming up this week, April 27th and 28th, the BoJ has an opportunity to act against the yen's momentum. With less than a week to go, on Friday, April 22nd, it seems the market finally decided to care about the prospects of BoJ action. FXY lost a whopping 1.9% in one day. This was the 20th largest decline in FXY since it first started trading. The last time FXY lost at least this much was March 24, 2010 (this was in the middle of a multi-year uptrend for FXY).
The CurrencyShares Japanese Yen ETF tumbled all the way back to its uptrending 50-day moving average (DMA). Continued selling will likely signal the end of 2016's uptrend.
At its 2016 peak on April 11th, FXY had gained 11.6% for the year. On that very day I happened to write "Watch Out For The Nuances Of The Japanese Yen's Relationship To The S&P 500" where I described my trading strategy on the yen:
"For trading in forex, I have decided to accumulate a growing long position in USD/JPY in anticipation of the day when the forces behind the yen's strength inevitably weaken and reverse. In the meantime, I am aggressively fading rallies (whether intraday or weekly) in GBP/JPY and AUD/JPY and taking profits whenever the next sell-off occurs."
If Friday's trading is a sign then, that "inevitable" reversal may have already begun.
While yen bulls may be finally unwinding positions ahead of the BoJ meeting, the release on Friday of a series of reports from the BoJ may have helped to grease the skids for FXY. One of these reports, the Financial System Report (April 2016), includes language that both speaks to the difficulties imposed by negative interest rates and attributes the yen's current appreciation to "heightened volatility in global financial markets" (emphasis mine):
"…a broad range of entities in financial markets have postponed their transactions as they have been in the midst of reviewing their investment strategies and operational arrangements, including their IT systems.Investors and firms have avoided transactions with a negative interest rate. As a result, signs of a holdup in the flow of funds have been observed, for example, a large sum of funds have remained within trust banks and major banks. Meanwhile, the heightened volatility in global financial markets after the beginning of 2016 has led to a decline in stock prices, yen appreciation, and an increase in foreign currency funding costs. It has also worked to restrain risk taking among financial institutions and other entities to some extent. The policy effects are expected to propagate further as these issues are resolved…
The shrinking population and customer base - in addition to the low interest rate environment - is exacerbating the problem of low profitability of regional banking especially."
The BoJ just cannot win with negative rates it seems. Clearly, negative interest rates are not yet working as hoped in Japan. The run-up in the currency since implementation of the negative rates has acted as a double-whammy. The currency's strength will impede the intended transmission of monetary policy. When faced with such potential failure, central banks have tended to do even more of the same under the presumption that the policy response simply has not been big and bad enough yet. If this behavior pattern persists, we should expect something especially dramatic out of the BoJ soon, even if it does not come with the upcoming meeting. The BoJ just needs to figure out a way to ameliorate the observed negative impact of negative rates (the tiered structure of rates was supposed to do the trick).
Interestingly, one of the many of the BoJ's talking points on solutions is to cooperate more with central banks. That sounds like the underpinnings for "currency cooperation"…
"As part of its effort to respond to financial globalization, the Bank will increase its coordination with overseas central banks and other organizations, while deepening its understanding of developments in the overseas financial system and financial markets."
If the BoJ decides to act in its next meeting, it has the fortune of stepping to the plate AFTER the U.S. Federal Reserve takes its next swing. The Fed issues its next statement on April 27th. So if Janet Yellen and company help soften up the U.S. dollar (NYSEARCA:UUP) yet again, the BoJ will know better just how much "scare" they need to put into the market to soften up the yen.
The unwind of maximum yen bullishness could trigger a move as dramatic as the run-up to current levels. I am bracing for a large reversal because the yen sticks out as a low-yielding currency, that has not participated in the renewed and broad success in carry trades in recent weeks and months. From Bloomberg on April 22nd:
"Carry trade returns reached the highest levels this week since Dec. 7, according the Deutsche Bank G10 FX Carry Basket Index. Since April 1, 29 of the 31 major currency carry trades funded in euros have made money, the most since October, according to data compiled by Bloomberg."
The absence of ANY mention of the Japanese yen stuck out like a sore thumb in this article. FXY's loss on Friday erased all its gains for April, so the catch-up may be underway. There is a lot more room to go if this reversal of maximum yen bullishness picks up support.
Be careful out there!
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.
Additional disclosure: In forex, I am long USD/JPY, short GBP/JPY, short AUD/JPY, and short euro