The Japanese yen is falling. That is in line with the country's economics and is propelling the carry trade. However, there may be some troubled waters ahead that will prompt the Japanese yen to rise. Non-farm payrolls will be released on Friday in the United States. The economy is trending lower. The Federal Reserve calls it transitory and that there will e continued strength in the consumer and the job market. But, a poor number on Friday has the potential to draw money out of the equity markets and into the bond markets. That would push the Japanese yen higher. I am interested in trading the carry trade but there may be better entry levels, and this week's data will provide that opportunity.
Right now, the carry trade is being propelled by the push and pull of the interest rate differential between the United States and Japan as well as other countries. In Japan, the Bank of Japan (BoJ) is keeping interest rates on the 10-year government bond yield between 0.00% and 0.10%. When the BoJ first announced this a lot of seasoned traders, myself included, whether the central bank could pull it off. So far, they have. There is one thing you will learn after trading a number of years: Never fight the BoJ. Ever. They may not be right initially, but through a tremendous amount of resolve they will get their way.
Whereas interest rates around the industrialized world have moved higher, the BoJ has been able to maintain there target threshold. Despite this, the effects on the economy and the currency have not been as robust as the BoJ may have wanted to achieve. If you look at July of 2016 interest rates were bottoming out around the world. The United States 10-year government bond yield was 1.42% while the Japanese 10-year government bond yield was -0.32%. Since then, respectively, the yields have risen to 2.4% and 0.2%. The BoJ has successfully held the long end of the yield lower while disproportionally the yield in the United States has risen far more.
But, the desired effect was to have inflation show up on a massive scale in Japan and the Japanese yen falling significantly was one of the key contributors to that. A look at a long term chart on the USDJPY and you can see the currency has done nothing more but to achieve middle ground.
Given the amount of push the BoJ has done to deflate the currency the USDJPY should be through the ceiling. That has not even come close to happening. Here is another chart showing how much the balance sheet for the Bank of Japan has ballooned:
The Bank of Japan has pushed their balance sheet from ¥100 trillion ye to ¥500 trillion yen. They appear to be set to continue this program until they achieve their intended results. But, it is my belief that the rest of the world has a better opportunity of pulling the Japanese economy forward more than the Japanese government themselves. Time will tell that.
In the meantime, jobs in the United States are due on Friday. The thinking is that the number will be soft but manageable. The Federal Reserve has called the recent pause in the economy "transitory", meaning, this is a pause and it will be brief. I disagree.
There are few factors that are far bigger than some want to acknowledge. The consumer debt situation And the slowdown of the consumer in the United States is telling in a very big way. I think the economy is "transitorially slowing" faster than imagined. But, I do not think we are about to enter a full-blown recession.
Translation: Jobs data may be weaker than expected. Because of that, traders will move out of equities and into debt. The inverse relationship of buying bonds will send yield lower. That will narrow the differential between the United States and Japan. USDJPY will move lower, sending the Japanese yen higher. I welcome this because there are other variables at play that will push the carry trade higher. A sharp move higher in the yen will offer an opportunity in other currency crosses.
I am looking to enter a long position in EURJPY or GBPJPY over the next couple of trading days. Because of the potential for the sharp rise in the yen this will offer a good buying opportunity in EURJPY and GBPJPY. Over the course of the next year I see the terms currencies of both EUR and GBP heading higher. And, eventually, the transitory nature of the U.S. economy will end and the economy will resume its expansion. Interest rates in the United States will head higher widening the differential.
Friday's jobs data will be very telling of the direction of the carry trade. But, ultimately, I think it is an entry point for the carry trade.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in JPY, JPYS, (LONG EURJPY) over 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.