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Takeaway: The Abenomics trade is now squarely underwater with an increasingly convoluted immediate-to-intermediate-term outlook.

SUMMARY BULLETS:

  • Over the past couple of months, the Abenomics trade has encountered a meaningful amount of resistance.Specifically, both the USD/JPY cross and the Japanese equity market are making lower-highs relative to the YTD highs that were established on 5/17 and 5/22, respectively. In a way, this is the Global Macro equivalent to being underwater relative to previously-established high water marks.
  • For now, there is little from an absolute or relative policy perspective that supports a continuation of recent market movements.
  • Regarding Japanese monetary policy, BoJ Governor Kuroda delivered a thorough presentation today to the Research Institute of Japan. Having read through the full transcript of Kuroda’s lengthy speech, there was hardly anything incremental as it relates to the outlook for the BoJ’s “Quantitative and Qualitative Easing” program and our commensurate outlook for JPY debasement.
  • The one caveat to that statement is that the BoJ is forecasting that +2% inflation will not be reached until the second half of FY15, which is roughly six months later than initial expectations. That takes some wind out of our sails as it relates to our real interest rate differential argument on why the USD is likely to appreciate another 12-27% vis-à-vis the JPY over the next 12-18 months. Now we’re looking at a catalyst that is closer to 18-24 months away, which is an obvious negative for preexisting long-USD positions in the futures, forwards and options markets.
  • Anything can happen at this Wednesday’s FOMC meeting. If the US monetary policy powers-that-be decide to debauch the USD from here (stymying US growth in the process), all bets are off as it relates to the Abenomics trade from an immediate-to-intermediate-term perspective – particularly in the event that TREND support for the USD/JPY cross and Nikkei 225 confirm any violation to the downside that is also confirmed by a TREND line breakdown in the US Dollar Index.
  • We don’t disrespect TREND line breakdowns (or breakouts) and neither should you to the extent you have been involved in this trade. Absent a marked shift in Fed policy from previously-issued guidance, our long-term thesis with respect to the Abenomics trade hasn’t changed one bit. That said, however, investors must remain mentally flexible enough to respect – and potentially profit from – the nonlinearity involved with traveling from point A to point B in financial markets.

From a long-term perspective, you know where we stand with respect to the Abenomics trade. Specifically, we are calling for the USD/JPY cross to trend ~12-27% higher from current levels over the intermediate-to-long term, which would likely continue to prove positive for Japanese equity reflation – assuming interest rate volatility remains muted (which is certainly a big “if” indeed).

It’s the same thesis we authored last fall and nothing from a fundamental perspective (i.e. relative and absolute monetary and fiscal policy) has us even considering to consider abandoning this view. For those of you who may be new to this thesis or our research behind it, we encourage you to review the following notes:

Over the past couple of months, however, the Abenomics trade has encountered a meaningful amount of resistance. Specifically, both the USD/JPY cross and the Japanese equity market are making lower-highs relative to the YTD highs that were established on 5/17 and 5/22, respectively. In a way, this is the Global Macro equivalent to being underwater relative to previously-established high water marks.

LOWER HIGHS: IS IT TIME TO BOOK GAINS IN THE ABENOMICS TRADE? - USDJPY

 

LOWER HIGHS: IS IT TIME TO BOOK GAINS IN THE ABENOMICS TRADE? - Nikkei 225

In the context of the LDP-NKP coalition securing the necessary votes for a bi-cameral majority in the recent Upper House election – which effectively grants them the right to pursue a variety of game-changing fiscal and monetary policies in pursuit of their +5% “monetary math” target – the aforementioned lower-highs are an ominous sign indeed.

For now, there is little from an absolute or relative policy perspective that supports a continuation of recent market movements.

Regarding Japanese fiscal policy, the market is still waiting with baited breath on credible fiscal reform strategies and whether or not the consumption tax will be hiked in FY14 as currently planned. It’s too early to tell whether or not there will be any material disappointments or positive surprises emanating from this arena. The market is truly in wait-and-see mode on this front.

Regarding Japanese monetary policy, BoJ Governor Kuroda delivered a thorough presentation today to the Research Institute of Japan. Having read through the full transcript of Kuroda’s lengthy speech, there was hardly anything incremental as it relates to the outlook for the BoJ’s “Quantitative and Qualitative Easing” program and our commensurate outlook for JPY debasement.

The one caveat to that statement is that the BoJ is forecasting that +2% inflation will not be reached until the second half of FY15, which is roughly six months later than initial expectations. That takes some wind out of our sails as it relates to our real interest rate differential argument on why the USD is likely to appreciate another 12-27% vis-à-vis the JPY over the next 12-18 months. Now we’re looking at a catalyst that is closer to 18-24 months away, which is an obvious negative for preexisting long-USD positions in the futures, forwards and options markets.

LOWER HIGHS: IS IT TIME TO BOOK GAINS IN THE ABENOMICS TRADE? - BoJ Forecasts

It’s important to remember that everything that matters in Global Macro trading occurs on the margin; prospect theory best describes this view from an academic perspective. With that in mind, we can see why the dollar-yen rate and the Nikkei are backing off here, forming lower-highs in the process. Whether or not they hold on to current higher-lows and, more importantly, their respective TREND lines of support is the key question as it relates to your gross exposure to this trade.

Anything can happen at this Wednesday’s FOMC meeting. If the US monetary policy powers-that-be decide to debauch the USD from here (stymying US growth in the process), all bets are off as it relates to the Abenomics trade from an immediate-to-intermediate-term perspective – particularly in the event that TREND support for the USD/JPY cross and Nikkei 225 confirm any violation to the downside that is also confirmed by a TREND line breakdown in the US Dollar Index.

LOWER HIGHS: IS IT TIME TO BOOK GAINS IN THE ABENOMICS TRADE? - DXY

We don’t disrespect TREND line breakdowns (or breakouts) and neither should you to the extent you have been involved in this trade. Absent a marked shift in Fed policy from previously-issued guidance, our long-term thesis with respect to the Abenomics trade hasn’t changed one bit. That said, however, investors must remain mentally flexible enough to respect – and potentially profit from – the nonlinearity involved with traveling from point A to point B in financial markets.

Stay tuned.

Darius Dale

Senior Analyst