the gestalt shift

Forex Fundamental Analysis: View on the Yen with Paul Stafford

I must admit that I have a hard time maintaining an open mind on the yen. I see so many issues impacting the currency relative to the other G-7 that when good news does happen, I tend to discount it (my own “confirmatory bias” peeking through). So let’s start with my predilection that the Yen is due for a fall, and then try to discredit it.

 The fundamentals certainly do give one pause. The central bank rate has been 0.1% for years, and of course gave rise to the Carry Trade. With the recent increases moving short term US interest rates above Japanese rates, a resurgence of the Carry Trade will drive the Yen lower. Other measures of the economy are woeful too. The GDP took the worst fall of all the G-7 last year (-12.7% annualized in March 2009), and monthly change in GDP remains negative, although improved from a year ago. Amongst the G-7, the budget deficit is third worst (behind the US and UK) at -7.8%.

 The CPI has been negative for over a year, and remains so even though other nations are have been seeing positive numbers for a while now. Of and by itself, a negative CPI is no crime, but the deflation it indicates has plagued Japan for several decades now, and unless policy changes, will sap the strength of the economy.

 The last few years of Yen strength have severely impacted Japan’s export economy. As you can see from the chart, the Yen is still near historic highs against the $. That is important. The US, consuming 20% of Japanese exports, is Japan’s largest trading partner by far (China comes in 2^nd at 15%, and the Yuan is pegged to the $).

USD/JPY Chart

The recent $56B increase in the borrowing limits for the foreign exchange special account indicates to me that intervention is a distinct possibility. The Bank of Japan has done it before, they will do it again.

Sovereign risk, as measured by CDS rates, remains among the highest in the G-7 (recently 63 bps, compared to the US at 48 bps, Germany at 34 and France at 43 bps), only recently being eclipsed by the UK. This is probably a result of the absolutely huge public debt that Japan has, forecast to exceed 225% of GDP by the end of this year. In a similar measure, Standard and Poors recently downgraded the outlook from stable to negative. While Japan’s debt still carries an AAA rating, the UK is the only other G-7 country with a negative outlook.

The long term macro view is hardly any better. Everyone is familiar with the serious demographic issues facing Japan. Its population is both shrinking (forecast -.2%/yr) and aging (30% of the population is over 60). Because of its unique culture, net immigration is negligible. Japan imports more than 80% of its energy needs, and so is very sensitive to the price of oil. The huge public debt overhangs it all. The Nikkei 225 is 25% of its 1990 high (chart courtesy yahoo finance)

Japan Nikkei Chart

A good trader always looks for data opposing his view. On the plus side, unemployment in Japan is only 7.8%, and Japan also carries a positive current account balance. Sentiment indicators are still bullish Yen, with the last 25 Delta risk reversal I saw on the $/JPY at -1.25 (quote from Super Derivatives), and CME futures are roughly 2:1 long Yen. The huge public debt is mainly held domestically, as opposed to the huge US public debt, which is mainly held offshore. With a growing China as a trading partner, exports should strengthen, and the recent increase in renminbi short-term forwards indicating a potentially stronger Chinese currency should also help.

In spite of those contra indications, my expectation for a weaker Yen remains. A stronger Yen hurts the export economy, and exacerbates the deflation currently strangling Japan. Monetary policy must move for a weaker Yen. Only risk aversion, which paradoxically (to me) benefits the Yen)  can keep the Yen in its current range.

Paul Stafford

http://4xTradertools.com 

For more strategies on how to capitalize on this move go here

Wednesday, March 10th, 2010, by admin and is filed under "Paul Stafford, Trades, analysis, carry trade, forex fundamental analysis, forex trading strategy, forex trading tutorial, stronger Yen, weaker Yen ". You can leave a response here, or send a Trackback from your own site.