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Takeaway: If you weren’t long the dollar-yen rate prior to yesterday’s bloodbath, you’re getting an excellent buying opportunity here.

SUMMARY BULLETS:

  • While the confluence of events that occurred this week to trigger yesterday's move are increasingly obvious in the rear-view mirror (Abe’s disappointing “Third Arrow” outline, rising US growth fears and ECB “hawkishness”), we think the events – or lack thereof – that perpetuated yesterday’s downside are even more important to elucidate: 1) a lack of liquidity as stop-loss programs were triggered; 2) the FX market betting that the BOJ would remain a lame duck over the immediate-term; and 3) the FX market betting that the MoF would refrain from outright intervention.
  • Since we are firm believers that relative monetary and fiscal policy deltas is the primary factor(s) in determining exchange rates, we continue to think the structural bear case for the yen is even better than the commensurate bear thesis for the USD was, say, over the past 3-4 years. Moreover, the USD/JPY cross more or less banged right off of our 95.66 TREND line of support this morning and is now a full +2% higher intra-day.
  • As long as that cross remains bullish from a intermediate-term TREND perspective, we are inclined to maintain our bearish bias on the Japanese yen and we will continue to fade any JPY strength at key risk management levels.

After a move like the one we saw in the USD/JPY cross yesterday (-2.1%; the largest 1-day decline since MAY 20, 2010), it would be natural for us to start this note off by pointing to how much the yen has declined since we introduced our bearish thesis late SEP ‘12. We have no intention of doing so; that would be embarrassingly akin to Tom Brady calling up ESPN to remind the world about how many Super Bowls he used to win.

Rather, we’d thought we take a few moments to dissect why we have had this call wrong in recent days and weeks; the JPY has traded up +3.2% WTD vs. the USD and is now up +6.0% from its YTD low on MAY 17. As a quick aside, we are keen to remind investors something we’ve been aggressively stating since we first opened the doors here @Hedgeye; specifically, Big Government Intervention has two very critical unintended consequences:

  1. Shortened economic cycles; and
  2. Amplified market volatility.

While the confluence of events that occurred this week to trigger yesterday's move are increasingly obvious in the rear-view mirror (Abe’s disappointing “Third Arrow” outline, rising US growth fears and ECB “hawkishness”), we think the events – or lack thereof – that perpetuated yesterday’s downside are even more important to elucidate:

1. NO LIQUIDITY

Breaking the 99 barrier on the USD/JPY cross looks like it triggered a massive stop loss program and, because of the new rules issued by Japan’s FSA last Friday (designed to “protect investors” and “limit speculation”), there’s hardly any liquidity left in the marketplace to take the other side of the trade via intraday speculation. Per StreetAccount:

Under a self-regulation proposal to be adopted on Friday, forex firms will be required to settle a trade even when the move is in the trader's favor. The FSA also plans to restrict trading in binary option and as early as this year, the FSA will ban trades that are looking fewer than 2 hours ahead. The FSA also plans to strengthen oversight of forex companies which offer automated trade programs.”

2. NO KURODA

On monetary policy, it’s important to remember that the BOJ is already committed to monetizing ¥132 trillion through EOY ’14 (27.7% of 2012 nominal GDP) vs. the Fed’s $2.04 trillion (13% of 2012 nominal GDP) over the same time period – assuming the Fed continues at the current pace of $85 billion per month through EOY ’14 (a very unlikely scenario in our opinion). The BOJ’s relative aggression limits what they can do in short order due to international pushback with regards to the yen’s precipitous decline on a trade-weighted basis.

YEN CAPITULATION? - 1

We believe the BOJ will have to wait to be disappointed on the nominal GDP and CPI front several quarters from now before they can reasonably justify any demonstrable, market-moving increase in the pace of their asset purchases – unless, of course, they use elevated JGB volatility as political cover to get more aggressive. Time will tell on that, but board members are indeed openly concerned with respect to that political headwind (as evidenced by them increasing the frequency of their JGB purchases in the current month).

At any rate, our best guess is that the BOJ board will be inclined to continue waiting and watching, and that’s clearly what forex market participants were betting on this week/in recent weeks. BOJ board members have been aggressively marketing the recent regime change which took place upon Kuroda’s arrival, so doubling down this soon would be a tacit admission of defeat and a return to the old days of ineffective, incremental easing.

3. NO TARO ASO

Overnight, Finance Minister Taro Aso was out stating that the MoF had no intention of direct intervention in the FX market. We don’t blame him; that would A) markedly increase the international scrutiny upon Japan’s Policies To Inflate and B) remind investors of the old days of ineffective one-off interventions.

The last thing the Abenomics agenda needs right now is another blow to market confidence – especially one that stems from them looking more and more like previous LDP regimes. Aso astutely recognizes this risk and is willing to take the short-term pain for the long-term “gain” that is outsized currency debauchery.

WHERE TO FROM HERE?

Since we are firm believers that relative monetary and fiscal policy deltas is the primary factor(s) in determining exchange rates, we continue to think the structural bear case for the yen is even better than the commensurate bear thesis for the USD was, say, over the past 3-4 years. Moreover, the USD/JPY cross more or less banged right off of our 95.66 TREND line of support this morning and is now a full +2% higher intra-day.

YEN CAPITULATION? - 2

As long as that cross remains bullish from a intermediate-term TREND perspective, we are inclined to maintain our bearish bias on the Japanese yen and we will continue to fade any JPY strength at key risk management levels.

At this point, it's not a matter of "if" the Fed will tighten US monetary policy at the margins, but "when". More importantly, that "when" is sure to be well ahead of any tightening out of the BOJ. Layer on the impact of sequestration domestically and the impact of recent stimulus spending in Japan and we continue to have a meaningful fiscal policy bifurcation to layer on to the thesis as well. At any rate, we're still waiting to hear a legitimate bull case for the yen...

YEN CAPITULATION? - 3

Global macro risk management is not easy, folks, but it sure is exiting!

Darius Dale

Senior Analyst