Our calls that the central bank of Japan was maxed July 18th and last week are now taking center stage. The yen (NYSEARCA:FXY) is rising on that news Friday and this week. Multiple reports have come out now showing how Japan has reached its monetary stimulus max. Some reports even say the BOJ is considering a pullback. We are in a period of a peak of a key stock market driver.
Our call that the yen rising is a key market risk is also getting out there now. We think this could also take center stage soon.
The US QE has already peaked and has come down some. Europe is also already maxed out. We are getting closer to the peak of the overall quantitative easing story.
The market has hardly managed to go up in the last two years. If some of these key drivers turn negative, markets (NYSEARCA:SPY) have a huge risk.
Yen Can Go Higher Because Of Max Rating
On July 26th ahead of the BOJ meeting last Friday, we gave the Yen the Pepsi Max Rating saying it can go up on a disappointing BOJ outcome. The BOJ monetary stimulus ended up being much less than the Street expected and sent the yen higher.
We wrote on July 26th and July 18th that the BOJ has run out of bonds to buy. For that reason, even if they raised their monetary plans, they couldn't do anything about it.
Here's what the WSJ reported July 29th.
"People at the BOJ have suggested that it couldn't significantly expand its JGB purchases from the current ¥80 trillion annually without straining the market. The BOJ owns more than a third of outstanding JGBs, with its balance sheet rising to 85% of gross domestic product as of May."
Max Rating. The BOJ is maxed. They can't do any more stimulus if they tried, so they aren't going to try. Japan has turned to fiscal stimulus instead which is bullish for the yen as monetary easing stalls.
Also on July 29th Bloomberg reported, "Today's decision suggests that the BOJ has reached the limits of its current policy framework."
In fact, we were surprised to hear that "pulling back" is on the table.
That same WSJ article said the BOJ is looking at "drawbacks of its easing measures."
As a sign how maxed Japan is, PM Abe strongly encouraged the BOJ last week to ease alongside the fiscal measures this week.
Even with that strong message from their leader, all the BOJ could eke out was ETF buying. ETFs for us do not have the multiplier lending effect and if anything, are a one-time benefit.
Here's the yen. We said that there are multiple risks that build with a drop below 100 dollar/yen (NYSEARCA:UUP). We're quickly approaching that level.
This chart goes back about 9 years. You see that 100 dollar/yen has been a critical juncture up and down.
After a huge push by Japan to weaken their currency since 2013, the yen has come all the way back.
The 100 dollar/yen mark has been a key support/resistance over the last decade as you can see in the chart.
We think as we go below 100, Japanese foreign investments will turn negative causing them to sell.
Below 100 Dollar/Yen Could Ring Currency Manipulator Alarms
We also said below 100 will stir Japanese officials to want to step in and flat-out sell the yen. That would anger US trading partners that would enforce penalties against Japan.
That is one reason, we think this stimulus package has been so big. Japan could not sell the yen straight because US officials would put tariffs on Japanese goods as a penalty. The only move that could circumvent straight selling was flush the market with the yen through bond purchases. It hasn't worked.
We think a drop below 100 could cause Japan to switch gears and straight-out sell the yen despite the US penalties.
We think that would cause other countries to also need to compete and downgrade their own currency's value. That would cause market volatility.
Another impact to Japan of a strong yen is profitability. Bloomberg reported that 102-103 is a crossover point in which Japanese exporters turn to a loss. The lower sales in foreign currency squeezes the margins because costs are in the higher home currency. 18% of Japan's GDP is exports of which the US makes up about 20%.
Any penalty from the US would have harsh economic consequences.
Strong yen had meant weak stocks
Yesterday, CNBC reported that this yen chart is a "warning sign" for global markets, something we had been saying for some time.
Here's the dollar/yen versus the stock market.
You can see that the SPY (in blue) has tracked the dollar/yen in red and green. They diverged of late. We think a crossover of 100 dollar/yen would be important enough to wake this correlation back up based on the fundamental implications.
Recent Two Events Met With Yen Buying
Here's the last week of yen trading. Below is a dollar/yen chart. Down means a strong yen.
The last two events of monetary policy (Friday) and fiscal policy (this week) met with yen buying. (Down means a strong yen)
The fear that Japan can add more yen to the market is reduced. Any further news, we think will be more of the same disappointment since Japan has been maxed out.
These news events can further cause market forces to push the yen below 100. Even if Japan comes out to say they will defend the yen, they can't unless they want to take an economic hit from a top trading partner (The US.).
They are stuck.
Either they have to let the yen rise which will be a market risk based on fundamentals and market correlations. Or they step in and cause their economy to suffer which would be a global risk.
Japan bonds worst drop in years
Japanese bonds had their biggest 3-day drop in three years. That is moving up their yields. If market forces adjust global yields up that will be a market risk. The stock market has been held up by low yields. A jump in those yields, therefore, is a clear market risk.
The fact that Japan can't buy any more bonds may be a reason that bonds are starting to fall. Japan Bonds lost their biggest incremental buyer.
The last two events in Japan in less than a week have sent the yen higher. We think in that yen are multiple real global risks. Crossing over 100 we think will be a negative market catalyst.
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Disclosure: I am/we are long YEN, SHORT SPY, IT CAN CHANGE AT ANY TIME.
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