Why You Should Watch the Japanese Yen.
With the year quickly drawing to a close I thought it was a good idea to look at the big picture in a few key markets.
One of the most interesting recent developments has been the large move in the Japanese yen. The LDP (Liberal Democratic Party) just won the election last Sunday, and the market expects to see far more money printing under the LDP.
A recent Reuters article pointed out that:
‘Even before Japanese voters returned Shinzo Abe’s party to power, he had already won over financial markets with an economic revival plan as seductively simple as economists say it is risky: print money and spend it. Lots of it.
‘The Liberal Democratic Party’s landslide on Sunday is likely to sustain a market rally fuelled by economic stimulus hopes, but Abe’s economic legacy will probably be defined by how he tackles chronic ills that easy money alone cannot fix and that were largely ignored during the campaign.’
So after two decades of printing money and spending it without successfully reviving the Japanese economy, they’ve decided to give it another go.
Japan really is the poster child for failed Keynesian stimulus policies. Their debt to GDP is approaching 240% and their interest rates have been near zero for longer than anyone else and they’re still stuck in a deflationary depression.
As Albert Einstein said, the definition of insanity is ‘doing the same thing over and over again and expecting a different result’. It looks like we’re about to witness more of the same from Japan…
Watch the Japanese YenThe reason this is interesting is that the yen is finally cracking after rallying for six years. The government has intervened in the currency markets over the past couple of years in an attempt to weaken what was a very strong yen.
It looks like the recent LDP victory and their promise of firing up the printing presses has finally convinced the market to start selling the yen.
Equity markets were driven for years by the yen carry trade which involved financial players borrowing in the Yen and investing offshore. That’s why the euro/yen cross rate was always used as a ‘risk proxy’. It gives a hint about large capital flows.
Euro/Yen Daily Chart vs ASX 200
You can see from the above chart that the euro/yen has shot higher in the last month and we have had a corresponding move in our equity market. The correlation has actually been quite high between the two over the last few years.
So is the yen carry trade coming back into fashion? If they’re going to attempt printing their way to prosperity again does that give market players the confidence that the yen will continue to depreciate and therefore reduce risk in placing yen carry trades?
If this is the case then we may see stock markets continue higher on the back of this phenomenon. The race to the bottom in the world’s majorcurrencies is having a profound effect on markets worldwide and I have been caught off guard by the continuing resilience of equity markets in the face of deteriorating fundamentals.
Our equity market in particular is now flirting with some very important technical levels. For the last three years the 4600-4700 area in the ASX 200 has been an important dividing line for our market. I would expect to see some very stiff resistance in that zone.
ASX 200 Daily Chart
If we manage to bust up through the Point of Control at 4700 then I will certainly scratch my head, but also accept that I was wrong to be so bearish.
We need to see the ASX 200 close below 4450 in the near term for me to reinitiate my strongly bearish view. Until that happens I have to maintain a wait and see approach. It looks like we are having the Santa rally that happens so often.
There will be plenty of fund managers wanting to window dress their results into the end of the year, so I accept that there isn’t much chance of a big sell-off over the next few weeks unless there is a complete breakdown in negotiations over the fiscal cliff.
You can see quite clearly that the high correlation between the Australian dollar and the CRB index, which is a basket of commodities, has broken down quite dramatically over the last few months.
The Aussie/yen is also powering higher due to the strength of the Aussie dollar and the weakness of the yen combined. The Aussie/yen is another cross rate that people use as a risk proxy.
It appears that there are some large offshore capital flows currently driving the direction of our markets. The lack of yield worldwide is of course the ultimate reason for these flows, and this state of affairs could continue to the foreseeable future.
The bears have gone back into hibernation once again.
But I think 2013 could see this reverse once the economic slowdown becomes impossible to ignore.
This article is contributed by Money Morning. Click Here to Subscribe to their free newsletter.