Yen Gets Official Pepsi Max Rating, Expect Lower US Stocks

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Summary

Japan is maxed out.

We think their only incremental move will be in the form of fiscal policy which will not happen until August and voted in September.

We are bullish on yen from here although there are many negative global implications for a strong yen.

We think a strong yen should imply weak US markets.

The BOJ meets and will have an announcement to update their policy on Friday. We think the BOJ is totally maxed out. We've reported that the BOJ is running out of bonds to buy in Japan (Fed Prays). That tells us that whatever they decide to do this week, they are already at full throttle. That means the yen should strengthen against the dollar. Until recently there was a very tight correlation between a strong dollar/yen and a strong US stock market (NYSEARCA:SPY). For that reason we are bearish on US stocks.

Let's first look at a great chart of the US dollar (NYSEARCA:UUP) versus the yen (NYSEARCA:FXY).

You can see here that the dollar was in a downtrend versus the yen. In reverse the yen is in an uptrend. The dollar is testing to change that trend to get more bullish. We think the yen will strengthen turning this chart back down.

Here's the chart.

The green and red is the dollar versus the yen. You can see it's been in a clear down trend this year. You can also see that the dollar is at the top end of the downtrend trying to test it and possibly break the downtrend, which would be bullish.

We think the dollar downtrend will continue, however. That means we think the yen will lift again.

We think there are three main reasons that the yen has been strong

1) A lot of Japan's stimulus is behind them.

2) They can't do much more stimulus in the future even if they try which they might.

3) The US keeps warning them of a currency manipulator status which could throw off Japan's exports which would throw off their economy.

Let's review each point.

1st reason why the yen is strong:

When Japan started their stimulus three years ago they were already pedal to the medal. We think they are out of bullets.

Japan did too much at the start. You can see the market doesn't believe that they have much left. Look at the yen versus when they started their easing process. It's all the way back.

(Source: Bloomberg)

All that hard work to weaken their own currency is out the window. Mounds of money are for naught. We think Japanese officials have to be frustrated with this outcome. The yen's making the Japanese policy makers look bad. We will explain why we think this has global ramifications.

Second Reason Why The Yen Is Strong:

They can't do much more stimulus in the future even if they try which they might.

Japan has almost purchased up as much as they can (Much like the ECB). Japan has run out of sellers for the government to buy the bonds.

That tells us that even if the BOJ ups their easing schedule, they can't ease any further. They are already maxed out.

(Picture: We think the BOJ may have had too much of this to drink which may be why they are maxed.)

3rd reason why the yen is strong:

The US keeps warning Japan not to fall into manipulator status which could throw off Japan's exports which would throw off their economy.

The penalty for such manipulation could put trade pressure on Japan by limiting trade or adding tariffs on Japanese goods.

What's it matter to US investors?

Here is a longer term dollar yen chart. You can see the blue line SPY went in lockstep with the dollar yen until lately.

The yen has strengthened and the dollar has weakened. We think the yen is getting back to where it was before the Japan quantitative easing spree ("QE").

Based on the wiggles of the blue line (S&P 500) and the green and red (dollar versus yen) we think ultimately a down dollar means a down blue line stock market.

Key level is 100

We are currently at 104. The dollar yen recently tested 100 and bounced hard. We think, looking at the 5 year it is a critical line. We think the line is fundamentally and technically important.

It's technically important because it represents a key historic level of a giant breakout.

It's fundamentally important because it is about the time Japan and PM Abe started their QE spree. Breaking that level will likely frustrate the BOJ and the Japanese government. We think that will bring several risks to the fore.

1) Japan investors will see their dollar denominated investments breakdown and pull back further. That will cause selling.

Japan is the second largest investor in the US behind the UK (page 3, page 4 of pdf). It makes sense that if their investment charts breakdown because of the weakening dollar translation, they will pull back.

Here's the overall chart showing a falling US direct investment from foreigners.

The above chart shows investment into the US falling. We think when the dollar yen breaks 100 more Japanese investors will pull out. That could hit US markets.

2) Japan will be pressured to defend their currency which would anger the US.

If the dollar yen drops back below 100 we think Japan policy makers will be incredibly frustrated. This could push them to sell their currency which the US has warned them not to. It could create a trade war which would hurt the stock markets of both countries.

As trade weakens economies slow and all the stimulus stops working.

3) If Japan does try to weaken their currency other nations would join in to compete starting a currency war.

Since the global economy is interconnected a currency war would effect many global players. Currency volatility causes global market risk and instability. It also hits earnings of companies doing business there as well as generally spooks businesses and investors.

Friday's Event Risk

Traders and news have reported both expectations out of Japan. Some expect a further easing and some don't. We think that buyers of the yen are on the sidelines waiting to buy and if there isn't incremental easing they will come back in. We think even if there is a further easing the yen will hold. Why? Because they are already maxed. Therefore even on bad yen news, we think the yen can go up anyway which will tumble in all the sideline-waiting buyers.

Therefore we think Friday could be a bullish yen event.

If we are right that could be a negative US stock market event because of the geopolitical risk embedded in that currency and its multiple global implications (mentioned above).

Conclusion

We think the BOJ meeting could be a catalyst for a further strengthening of the yen. While many think that they may ease further, we think they are (Pepsi) maxed out. Either way we think buyers will come back after the event which means yen is itching to go up in either scenario.

If the yen goes up it will approach 100 dollar/yen. That is a critical level that we think could cause foreign selling of US assets and fears of Japanese currency intervention.

We are bullish on the yen and bearish on the US stock market.

Disclosure: Pepsi (NYSE:PEP) did not support or pay for this yen call in any way.

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Disclosure: I am/we are short SPY.

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.