Posted on: 20 Feb, 2020
The Yen is unquestionably the story of the week as the market tries to come to grips about what's caused such an implosion in the valuation of the Japanese currency. In this article, I look at the possible culprits that may have played a role in the astounding movement seen in the last 24h. Keep reading to find out..
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The Daily Edge is authored by Ivan Delgado, 10y Forex Trader veteran & Market Insights Commentator at Global Prime. Feel free to follow Ivan on Twitter & Youtube weekly show. You can also subscribe to the mailing list to receive Ivan’s Daily wrap. The purpose of this content is to provide an assessment of the conditions, taking an in-depth look of market dynamics - fundamentals and technicals - determine daily biases and assist one’s trading decisions.
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Few will argue that the hot topic of conversation online is the debacle of the Japanese currency. Some traders at banks are speculating that the correlation breakout of Gold and the Yen represents a paradigm shift in the logic to trade the Japanese currency. I personally disagree and suspect that when a move is so aggressive without apparent justification, there is hot money 'in the know' preparing for a potential ramp up of further easing by the BoJ. It might well be, as an alternative, that Japan’s Government Pension Investment Fund has opted to reshuffle its strategy seeking out higher yielding opportunities via USD-denominated instruments. What's clear is that no one can really pin point at this stage what's caused such a dramatic fall in the Yen value, but through history and economics, out of the list provided below, some could help you contextualize it.
* The Information is gathered after scanning top publications including the FT, WSJ, Reuters, Bloomberg, ForexLive, Institutional Bank Research reports.
BoJ as hidden catalyst? Whenever the Yen moves in the fashion it did without a single catalyst to justify such dramatic fall, the next likely origin is possibly an upcoming announcement that would represent a shift to easier policies by BOJ Chief Kuroda. Bank of Japan Governor Haruhiko Kuroda said this week that the central bank would consider additional “RAPID” easing if the coronavirus outbreak significantly threatened Japan’s economy and price trends, in news initially reported by the Sankei newspaper. “We would need to consider monetary policy steps if (the virus outbreak) significantly affects Japan’s economy,” Kuroda said.
So, is it affecting the Japanese economy? Japan missed its Q4 GDP in big style with a shocking -6.3% annualized contraction (largest since Q2 2014), which was a far cry from the expected -3.8% as the sales tax hike feeds through the economy. However, the market was unfazed by this number. The WSJ wrote a piece titled ‘Japan’s Third Sales-Tax Blunder Must Be Its Final Mistake’ arguing that the decision keeps suppressing household consumption. Adding to the bleak outlook, machine orders numbers fell 12.5% m/m in December this week, again, worse than the -8.9% reading expected. It looks as though this sluggish growth will extend into the first quarter as now Japan must deal with the impending risk of the COVID-19, most likely to affect the economic activity/sentiment, hence is looking increasingly likely that Japan will fall into a temporary recession. Amid this background, guess who’s ready to step in? The BOJ!
Why to expect slower growth in Japan? Japan has reported 74 cases, the third highest behind China and Singapore. The more cases it identifies, the greater the hit to activity. As the research team at NAB reported this morning, “weekly LNG imports into Japan are running cumulatively 21% lower than this time last year”, which is a poor sign indeed.
Japan’s focus no longer on elusive inflation but growth: This is precisely the reason why if the growth roadmap envisioned by the Central Bank shakes in a way previously unimaginable as the combo of the sales tax hike and COVID-19 hit the economy, the BOJ may genuinely be starting to strongly consider what else it can do to stimulate the economy. Remember that the economic fallout and soft consumption anticipated has forced the BOJ to message more strongly that it is no longer inclined to chase its elusive 2% inflation target. The BOJ seems to have conceded defeat on the CPI target but won’t allow the same sense of being beaten in economic growth. While the inflation target remains very important, the focus of the BOJ’s policy has shifted toward keeping the economy on a sustainable recovery path. Not achieving it is not an option.
Don't forget what Kuroda said in Sept 2019: Bank of Japan Governor Haruhiko Kuroda said in September last year that they were “more keen to ease than before since overseas risks are heightening”, and that was even before the third sales tax hike later that month or the headwinds in the economy caused by the COVID19! In terms of the options on the table, Kuroda said that if the central bank were to ease monetary policy further, “it would aim at pushing down short- and medium-term interest rates without flattening the yield curve too much.”
Too much money chasing too few assets: The Yen printed the worst daily losses in over 2 years. What’s astounding, which has left traders scratching their heads seeking out answers, is the fact that this is not a free-fall out of an across-the-board recovery in risk appetite. Far from it. One has to simply look at the price of Gold to realize that this long-held correlation is now shot to pieces. Gold denominated in JPY is now near its record highs from 1979. While it is very rare to see USDJPY and gold ballooning in-sync, the world is awash in a flood of money with few places to park excess liquidity. The rise in Gold or the continuous weakness in Oceanic currencies and the Yuan tells us another story, one characterized by an overarching sense of fear that the COVID-19 will take its toll in a magnitude greater than imagined, which will hamper the growth outlook for China and the world, hence easier policies will follow (more flooding of money).
Conflicting signals to buy into the narrative of COVID-19 ‘peak’ near: The Apple-led selling has been all but forgotten in the equity space. However, the implosion of the Yen, trust me, doesn’t mean the market is in a state of relief. The opposite might actually be true and it may start to be looking at the negative consequences its impact will have on easier policies this year. How does one explain the constant rise in gold then? If it keeps rising even of USD strength, this can’t be a good sign, as it indicates the flooding of more cheap money will make its way through. Bond yields continue to pay the same picture, still trading near trend lows. Bottom line, the COVID-19 has snowballed into the catalyst that will lead to further stimulus by Central Banks this year, and the BOJ, while not making headlines yet, may be next.
A sea change in the Yen dynamics: One of my old-held theories, which I’ve endorsed with ever greater conviction, as I’ve been able to exchange the views with top-notch institutional traders about it, is that the Yen declines, 99% of the times, occurs as a function of a reshuffling in portfolios by the mammoth-size Japan’s Government Pension Investment Fund (GPIF). Did you know it oversees the equivalent of $1.46 trillion? Why is it that the Yen tends to move in parallel to risk-on/risk-of movements then? The GPIF, as part of its constant adjustment of Yen-centered portfolio exposure, tends to sell Yens to buy US assets when conditions in equities are rosy. Karen Reichgott Fishman, an economist at Goldman Sachs in New York, said the yen’s “stubborn weakness” had been because of Japan’s Government Pension Investment Fund buying foreign assets, which has led to downward pressure on the currency. As the market has become more efficient and intertwined with algos ruling and constantly on the lookout for exploitable opportunities, this relationship was long-picked up and perfected. What’s important is that the Yen movement seen on Wednesday does not obey the normal dynamics.
US the safer bet to house your money: So, if the Yen move was not caused by the familiar correlation with risk appetite flows that leads to portfolio adjustments by the GPIF, what is it? The move is suspiciously resemblant of what we saw back in 2018 when the Yen went through an episode of sustained weakness on a mass exodus away from an economy with bad prospects and headed into America on the belief that the US is far more likely to weather the upcoming COVID19-led storm on global growth than any other country. Why? America's stimulative fiscal stance and higher-yielding currency. What’s more, the betting sites keep increasing the odds of another 4 years of Trump as US President after the fiasco by Democrats in Iowa. The New York Times carries a story titled ‘How the Iowa Caucuses Became an Epic Fiasco for Democrats.’
JPY finally losing its safe haven status? I will paraphrase Brent Donnelly, Spot FX Trader at HSBC, who in his overnight note to clients, noted the following: “The primary driver of JPY as a safe haven is supposed to be repatriation and the unwind of carry trades. If nobody is using JPY as a funder anymore, maybe there is no reason for the JPY to trade as a safe haven? Price action in the past year or two (JPY not working as a safe haven on North Korea, trade war, Iran fears) has raised the question. The price action overnight adds some urgency to the idea that we have crossed over into a new JPY regime.” I tend to simplify it to BOJ easing coming up.
Protect your downside if JPY long: At times, the market will have an uncanny ability to move towards the direction that is set to inflict the most pain. One will be hard-pressed not to agree that once the COVID-19 started to make it to mainstream media, the first thing that crossed investors' mind is to seek out the safety of the Yen. Through option products, widened stop losses triggered, the Yen may have been a crowded long not working out, which catches a large portion of the market off guard. Remember what economist John Maynard Keynes said, “The market can stay irrational longer than you can stay solvent.”
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By analyzing the chart of charts when it comes to understand the aggregated Yen flows, that is, my prop equally-weighted index, we can see a resolution lower. This fallout in the Yen has validated a breakout of structure, hence the notion of sell on strength ensues. There is further downside until the index meets its 100% measured movement, which acts as the default downside target that sellers are likely to target as part of this ongoing sell-side campaign.
Another chart that has gone vertical with no end in sight as momentum rules is Gold priced in JPY. This is a market that portrays like few others what I mentioned earlier about the world being washed with excessive liquidity yet very few options to park this money. Investing in Gold acts as a capital-preservation strategy against the constant devaluation of fiat currencies. The purchasing power of the US dollar since 1913, time when the Federal Reserve took over the US banking system has lost over 96%. Today’s dollar would be worth less than 4 cents back in 1913. Same story for Japan. How much has gold lost in purchasing power? Nill.
The next market, not to be forgotten, is the USD/JPY, which appears to be decisively en-route to target the next upside target circa the 112.00 level. As the chart below illustrates, the breakout above the previous swing high gives us permission now to draw the next 100% projection, which coincidentally, aligns to perfection with the next major weekly resistance area. All technical signs seem to point out at more pain ahead for USD/JPY shorts.
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