We have been yen bulls for an extended period. Now that we have reached our long-standing target of ¥85, we think that the risk-reward for holding long JPY positions is less interesting. Indeed, there are a number of factors which suggest that it’s a good time to book some profit in USD shorts and begin to use the JPY as the funding currency.
The roadmap for the 2009 FX market can easily be captured by the “punish the printer” theme. The most aggressive printers, namely the US and UK, have seen their currencies underperform, particularly against those currencies where the risk of printing was always close tozero — namely Australia, New Zealand and most EM countries such as Brazil. This theme has pushedv aluations to an extreme in most cases.
While the UK and US still have issues with respect to successfully reversing their balance-sheet expansion, and for that reason we still think the dollar and sterling will struggle to fully reverse this year’s losses until it is clear they can successfully exit their QE programs, the level of the yen on a relative basis suggests to us that it is a good time to substitute some dollar shorts for yen shorts. Playing a reversal of the “punish the printer” theme is perhaps one of the biggest currency
opportunities available in 2010, and we will continue to monitor it accordingly.
As can be seen in Exhibit 1, a basket of long USD and GBP against EUR and JPY is at fairly interesting levels for those inclined to fade the heavily populated “punish the printer” theme amongst the world’s four most liquid currencies. If we are right about USD/JPY, then this could start to turn now, especially as the EUR is around 30% expensive against both sterling and the dollar.
Why do we think USD/JPY is close to a bottom?
We think that Japanese authorities will want to resist yen strength around the ¥85 area, given that a break of this level sets up a test of all-time lows in USD/JPY around ¥80. Japan has not intervened in the currency market since 16 March 2004, not resisting the recent bout of dollar weakness. And despite risks to the domestic economy from the strong currency, they have kept to the spirit of the G20’s desire to deal with global imbalances. This has also been at a time when China’s renminbi has
been linked to a very weak dollar. Japan has been a good global citizen, but after this week’s surprise announcement of further liquidity measures by the Bank of Japan, it is perhaps an early indication that they are getting increasingly concerned about their economic prospects at a time when other central banks are thinking more about their exit strategies.
This might also imply that if the yen were to strengthen further the probability of intervention would rise quite sharply. Coordinated intervention cannot be ruled out either, given that Federal Reserve Chairman Bernanke has recently talked about a strong dollar being a source of global stability and that the Fed is attentive to the implications of changes in the value of the dollar and will formulate policy to guard against risks to their dual mandate. The recent Fed minutes also referred to the link between the dollar and inflation. There are many countries which are currently unhappy with dollar weakness (strength in their own currencies) or the low level of the federal funds rate such as the Eurozone, Canada, New Zealand, Switzerland, Brazil, Hong Kong, China and other Asian countries. A general stabilization of the dollar would suit everyone’s needs and help to contain any inflationary pressure in the US.
