IDEA ALERT: RE-SHORTING THE YEN, OUR FAVORITE CURRENCY SHORT ACROSS ASIA

Takeaway: We remain bearish on the JPY relative to the USD across our TRADE, TREND and TAIL durations.

SUMMARY BULLETS:

  • Earlier today, Keith re-shorted the Japanese yen in our Real-Time Alerts signaling product. This is not a new thesis to clients of Hedgeye Macro, so we’ll keep it tight (email us if you’d like to dialogue further on anything you see below):
  • We see downside risk in the JPY relative to the USD across our TRADE, TREND and TAIL durations, driven largely by our expectations for the BOJ to dramatically accelerate their monetary easing measures amid heightening political pressure, a rapidly-deteriorating domestic GROWTH outlook and a potential upward revision(s) to their long-term inflation target over the intermediate term.
  • Regarding the aforementioned point on political pressure, we think Japan’s looming debt ceiling showdown is likely to pull forward the timing of parliamentary elections from AUG ’13 to some point between now and the late NOV/early DEC breach.
  • If that catalyst occurs, we expect the LDP to regain control of the Diet based on the latest polls which show them taking a dramatic amount of share from the DPJ in recent months. The LDP has been openly in favor of a less independent central bank, incrementally-dovish monetary policy and incrementally-hawkish foreign policy towards China regarding the disputed islands. Judging by Japanese automakers’ SEP sales figures, the latter would be incrementally bearish for Japanese GROWTH – particularly from the BOJ’s perspective.
  • On the USD side of the trade, we think a Romney/Ryan victory is explicitly dollar-bullish. We have access to arguably the most accurate US presidential forecasting model in existence; that model suggests they’ll win in a landslide from an electoral college perspective.  John Taylor following Bernanke as Fed Chairman is a potentially positive tail risk for the USD if such a move were to be telegraphed in the context of the aforementioned scenario.

ECONOMIC CATALYSTS: Next week, we have the BOJ monetary policy meeting – which may be attended by new Economy Minister Seiji Maehara who is likely to seek to exert political pressure upon the board to ease – as well as a number of other economic data points that are likely to show Japanese GROWTH accelerating to the downside. That would be on the heels of yesterday’s dovish INFLATION report.

  • 10/28: SEP Retail Sales
  • 10/29: SEP Jobs Report; SEP Industrial Production; SEP Overall Household Spending
  • 10/30: BOJ Rate Decision; OCT Manufacturing PMI
  • 10/31: SEP Housing Starts; SEP Construction Orders
  • 11/1: OCT Vehicle Sales; OCT Monetary Base

RELEVANT RESEARCH: As previously mentioned, this is not a new thesis for our clients; if, however, you have not seen the relevant research notes, we encourage you to review the following reports:

  • 9/27: IDEA ALERT: SHORTING THE YEN AS SINO-JAPANESE TENSIONS ESCALATE
    • We are now short the Japanese yen (via the CurrencyShares Japanese Yen Trust etf “FXY”) in our Real-Time Positions product as a way to communicate our bearish TRADE and TREND thesis on the JPY relative to the USD.
    • The key catalyst in support of our bearish bias is a likely acceleration of the BOJ’s balance sheet expansion, which may include a potential implementation of a foreign asset purchase program as Japan’s economic outlook deteriorates on the margin due to slowing commerce with China and recent yen strength.
    • From a TAIL duration perspective, any sustained weakness in the yen risks Japanese banks and asset managers clearing out of the JGB market en masse in search of higher yields abroad (which they couldn’t do previously due to structural yen appreciation), as well as imposing the threat of structurally higher rates of inflation – a risk the JGB market hasn’t had to price in for over a decade.
  • 9/19: ARE CHINA AND JAPAN HEADING FOR WAR?
    • While we view the threat of military intervention as highly improbable, we do think the heightened tension over the Senkaku (Japan)/Diaoyu (China) islands risks facilitating a string of international protectionism – which is already poised to accelerate due to recent political promises out of the Obama and Romney camps.
    • Such protectionism would have dire economic effects globally, with Japanese industrial production and US/EU consumption getting hurt the most – the former due to lower Chinese demand; the latter due to higher import price inflation.
    • Retaliatory measures, while not an acute risk, could beget broader financial market and economic contagion globally. This is a meaningful TAIL risk, given the recent rhetoric and maneuvers of international policymakers.
  •  8/28: THE RAMIFICATIONS OF JAPAN’S LOOMING GOVERNMENT SHUTDOWN
    • The political calendar poses a great deal of risk to the Japanese economy, JGBs and Japanese financial institutions over the next ~2 months.
    • The ramifications of a potential/actual Japanese government shutdown are three-fold: a potential sovereign default; a potential sovereign credit rating downgrade(s); and an associated $75-80 billion capital call across the Japanese banking system in the event JGBs are downgraded to single-A level by Moody’s and/or Standard and Poor’s, where the outlook is already “negative”.
  •  7/27: ARE JAPANESE GOVERNMENT BONDS POISED TO MAKE SOME NOISE?
    • By authorizing BOJ purchases of foreign currency assets, Japanese policymakers risk materially elevating the risk of sustained yen depreciation and inflation within the JGB market.
    • Though we have yet to receive anything concrete on the policy front, we will be paying close attention to the next two BOJ monetary policy board meetings for signs of official movement in this direction. 
    • We are now short the Japanese yen (via the CurrencyShares Japanese Yen Trust etf “FXY”) in our Real-Time Positions product as a way to communicate our bearish TRADE and TREND thesis on the JPY relative to the USD.
    • The key catalyst in support of our bearish bias is a likely acceleration of the BOJ’s balance sheet expansion, which may include a potential implementation of a foreign asset purchase program as Japan’s economic outlook deteriorates on the margin due to slowing commerce with China and recent yen strength.
    • From a TAIL duration perspective, any sustained weakness in the yen risks Japanese banks and asset managers clearing out of the JGB market en masse in search of higher yields abroad (which they couldn’t do previously due to structural yen appreciation), as well as imposing the threat of structurally higher rates of inflation – a risk the JGB market hasn’t had to price in for over a decade.

Our updated levels on the CurrencyShares Japanese Yen Trust etf (FXY) are included in the chart below. Email us if you’d like our quantitative risk management levels for the USD/JPY cross as well.

Darius Dale

Senior Analyst

IDEA ALERT: RE-SHORTING THE YEN, OUR FAVORITE CURRENCY SHORT ACROSS ASIA - 1