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The Mother of All carry Trades Has Started

|Includes: ProShares UltraShort Yen ETF (YCS)
I’m hearing from my buddies in Japan that while things are already quite bad in that enchanting country, they are about to get a whole lot worse, and that it is time to start scaling into a major short in the yen.

Australia and China have already raised interest rates, to be followed by the US, and eventually Europe. With its economy enfeebled, the prospects of Japan raising rates substantially are close to nil, meaning the yield spread between the yen and other currencies is about to widen big time. In the case of the Australian dollar, that works out to 4% per annum. Leverage up ten to one, and pile on anticipated capital gains brought in by a weakening yen, and you have a real carry trade on your hands. That will generate hundreds of billions of dollars worth of cascading yen selling as hedge funds dog pile in. It’s macro investing at its finest.

Until now, the government has been able to finance ballooning budget deficits caused by two lost decades, but those days are coming to an end. Japan is quite literally running out of savers. The savings rate has dropped from 20% during my time there, to a spendthrift 3%, because real falling standards of living leave a lot less money for the piggy bank.

The national debt has rocketed to 190% of GDP, and 100% when you net out government agencies buying each other’s securities. Japan has the world’s worst demographic outlook. Unfunded pension liabilities are exploding. Other than once great cars and video games, what does Japan really have to offer the world these days, but a carry currency?

Until now, the government has been able to cover up these problems with tatami mats, because almost all of the debt it issued has been sold to domestic institutions. Now that this pool is drying up, there is nowhere else to go but foreign investors. With Greece and the rest of the PIIGS at the forefront, and awareness of sovereign risks heightening, this is going to be a much more discerning lot to deal with.

That great bell weather of global risk taking, the Euro/Yen cross is telling us that the mother of all carry trades has already started. On the release of Friday’s surprisingly positive nonfarm payroll numbers, the cross popped from ¥120 to ¥123.5, sending shorts scampering. You also see this in the Ausie/Yen cross, and outright yen markets. I have been piling clients into short positions since Thursday at the ¥88 handle, and they have already bagged an instant profit of ¥2.

You could dip your toe in the water here around ¥90. In a perfect world you could sell it as it double tops at the 85 level. My initial downside target is ¥105, and after that ¥120. If you’re not set up to trade in the futures or the interbank market like the big hedge funds, then take a look at the leveraged short yen ETF, the (NYSEARCA:YCS). This is a home run if you can get in at the right price.

For more iconoclastic and out of consensus analysis, you can always visit me at www.madhedgefundtrader.com , where the conventional wisdom is mercilessly flailed and tortured daily, or listen to me on Hedge Fund Radio at http://www.madhedgefundtrader.biz/ .