Speaking About Japan -US Dollar v JP Yen – A Currency Trade

A Contribution on Currency Trading from my friend Pete

The comments noted here are interesting and insightful. We at the Cymorfund do not trade currencies, and do not make recommendations in this area.

Larry, you spoke about Japan in your last post and I thought I would pick up on that, as there are some well-defined technical set-ups in the global macro space that have worked quite nicely of late and there is a great one in USD/JPY suggesting a substantial move in the near future.

Technical Signals
Before getting to that, technical signals that served well in the week past include a double top in the S&P futures Wednesday at 1098.50, right ahead of the Thursday meltdown, and a head and shoulders in the 2-year note futures Friday afternoon that augured for holding onto a short position established overnight – sure enough, despite a big bid coming out of nowhere to push the 2-year higher near mid-day when the 10-year was showing weakness, the shoulder at 109’230 held perfectly and ZT took it on the chin in the ensuing couple of hours, closing just above the low of the day.

Anyway, back to Japan and the interesting technical set-up in its currency. Like Dennis Gartman and others I too think that the yen, which is not far from its all-time high versus the US dollar, will at some point begin to weaken and just keep on going. Japan’s national balance sheet is terribly out of balance owing to misguided stimulus spending that achieved little, and the economy is, as has been typical for two decades now, just hanging on, growing for a while, grinding to a halt, then firing up again, then stumbling backward.

Identifying Exchange Rates
The key point is that one can identify exchange rates at which the Japanese economy will almost surely buckle. The only way USD/JPY could stay at such levels is if another country with significant financial heft and ilk or selfish intent was determined to hold it there (and even then the rate would eventually give way), or if the Asian countries that manipulate their exchange rates stopped doing so. We are not far from such a level right now, and in fact might actually be at such a level. But the yen remains strong, largely because of a shrinking gap between Japanese and US government debt yields and, I think, concern that when things get bad enough in Japan, they’ll start bringing some of their vast overseas holdings home.

A Long Term Double Bottom
At a few dozen basis points above 85.00, USD/JPY is sitting near a double bottom that goes back to November 2009 (84.83), and at this rate we are but 7% away from the strongest level the yen has ever seen (79.75) – needless to say, a very long-term double bottom. At 80 yen to the dollar the Japanese economy would be able to hold on no longer, so as long as one controls their leverage they likely need not worry about getting wiped out by a massive move that keeps surging to new all-time highs. By the way, those who think currency trading is dangerous should compare exchange rate volatility with that of your average stock. Currency movements in and of themselves present no more danger – it is the leverage that gets traders into trouble. Many people like global macro because they find the markets relatively logical (not to be confused with efficient…but that’s a discussion for another day).

Trade the Yen Now?
So, the question is whether to trade with the double bottom back to November 2009 and expect the yen to begin weakening almost immediately, wait and hope for yen strength to take USD/JPY a few yen under 85 and establish a short yen position which you could probably put in the drawer and visit in a couple of years to great delight, or, conversely, to go long the yen and ride the momentum. Fundamentally, the answer lies partly in action by the Japanese government (they won’t intervene, but the BOJ watches the technical levels in its currency very closely and will jawbone or otherwise exert influence to try to prevent technical breaks or add momentum to an existing move). And as much, if not more so, it lies in the trend of US interest rates, as watching Treasury’s and the yen intraday you’ll see the Japanese currency react immediately to changes in US interest rates.

Trendline
Technically, we are at the point where a trendline is going to force a decision. From a very short-term perspective, 85.95 is the number on the trendline that must hold if the yen reverses course and begins to weaken, although a less cherry-picked number would be 87.20. The medium-term number that would indicate a serious change of trend is bang on 92. Remember, though, these numbers all drop with each passing day).

On the other hand, yen strength that takes the rate decisively through 84.83 could gain speed quickly as stops are hit (it has already tried twice in the past couple of weeks, once actually getting below 84.83, but I’ll bet the tremendous move by the Japanese currency the day of the stock market “flash crash” taught many in the yen market about stops getting run), although it could probably be expected to stall out before long. My guess is that we’d see an inverse head and shoulders set up after that anyway.

Sentiment in the market also seems to have reversed, from so many saying just a couple of months ago that the yen would definitely weaken to just as many now saying that the yen will get stronger. It is good when sentiment is leaning to one side – it takes courage, but going the other way is often the right move.

A Short Yen Position
Momentum traders, of course, will say that a challenge of 79.75 is inevitable, and they may very well be right. But I’m leaning toward a small short yen position to be added to regardless of which way the exchange rate breaks. Anyway, the technical set up is there for both shorts and longs. The levels at which to establish positions are clear, as are the stops that would tell you when to reconsider. In the end, traders have to do their own comprehensive analysis and call their own shots (world’s shortest disclaimer), or just watch and see what happens and put it in the memory bank for next time.

Speaking of time, I’ve run out. All the best my good friend!