Yen’s Strength [has been] profoundly negative for global markets

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March 27th, 2008

March 27, 2008 - Donald Dony, The Technical Speculator, offers the following explanation of how the strengthening of the yen to a twelve year high against the US dollar has had a profoundly negative effect on global markets, in the past and during the most recent 6-7 months. We would also add that while Mr. Dony does a great job of explaining this concept, he also points out in the present tense that as the cheap money is quickly evaporating, so is the global market.

 

Our sense is that the yen broke through par, a level (usd/yen<100) that required intervention (which came last week), primarily by the BoJ to maintain it at levels that are more supportive of Japan’s economy. For this reason, it may be that if the yen has reached a turning point, that a new round of carry trade in the yen could provide stimulus and/or support to global markets at these levels. Change that to evaporated, past tense.

 

Global equity traders had, for many years, a ready source of funds at almost no interest charge. Traders have been shorting the Yen and using the funds to purchase stocks, currencies and high-yielding securities around the world. However, as of mid-2007, that “free bank account” is becoming more and more costly. The Yen carry trade is starting to unwind with very negative results for stocks.

 

But what is the “Yen carry trade”? Simply put, it is borrowing at very low interest rates in Yen and using the loan to buy higher yielding assets elsewhere. During the past 12 years, the trade has become standard business practice for many institutional investors. Perhaps the most popular form of the strategy exploits the yield gap between U.S. and Japanese fixed income securities. Another plus that came with the Yen/U.S. cross was from the dollar’s rise against the yen. Investors make their profit when they reverse the trade and pay back the Yen loan.

But all of this endless liquidity is quickly coming to an end and with bearish consequences to global equity markets.

 

Chart 1 illustrates the tight connection of the Japanese currency with global stocks. With every major rise of the Yen throughout 2007, there was a mirrored decline in the Dow Jones World Stock Index. Quite simply, the global equity markets began to fall when the tap was turned off to cheap money. Traders are now forced to buy back massive Yen short positions and sell assets to pay for it.

And what is happening to the Yen?

 

Chart 2 shows the Japaneses currency is breaking through a decade old resistance levels and surging to new highs. And this trend shows no signs of reversing. The upside target is 120.

 

Bottom line: The bearish impact of the advancing Yen is clearly apparent on global stock markets. World equities appear to have been propped up largely due to the availability of foreign liquidity. As this “cheap money” is quickly evaporating, so is the global bull market.

 

Donald W. Dony FCSI, MFTA

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2 Responses to “Yen’s Strength [has been] profoundly negative for global markets”

  1. Richard Says:
    June 30th, 2008 at 11:42 am

    The daily chart of EUR/JPY, FXE:FXY, the barometer of the yen carry trade, shows that the yen carry trade is unwinding. The weekly chart of FXE:FXY shows that the yen carry trade has topped out.

    Crown Forex writes “As for the Yen being the star in the forex market, risk aversion and investors risk appetite was able to help the yen gain against majors in the markets as investors were unwinding their carry trades taking the USD/JPY pair down to the 106.20s as the dollar continues to lose ground. Against the Euro, the yen gained from a record low at 169.45 to continue dragging the pair down to the current support level at 167.12 while the GBP/JPY is currently at 211.10s”.

    Risk aversion has come to the traditionally yen-carry-trade favored BRICs: there is significant disinvestment from Brazil, EWZ, Russia, RSX, India, INP, and China, FXI.

    And risk aversion will rise significantly as corporate profits turn down; investors who sell stocks will be looking to the financial safehaven of gold.

    And a higher yen means a lower US dollar; in as much as gold trades inversely of the dollar; gold will be going up.

  2. GreenLight Advisor Says:
    June 30th, 2008 at 3:13 pm

    Richard, it does appear that is what is happening.

    Central bank intervention in the dollar is no longer having the desired effect, now that the Fed has stood down on a rate hike for the time being.

    Shorting gold futures might prove to be a terrible strategy for lending support to the ailing dollar, given the new round of uncertainty kicked off by the downgrading of yet more monoline credit ratings.

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