Yen Tips Its Hand… For Now

In a recent post “Watching The Yen Like An Avian Creature Of The Predatory Nature” I suggested the Yen was near a major tipping point. As of this morning we may have been given an indication of the direction of the Yen. A strong breakout above the 10 month trend line with accelerating momentum is a very bullish signal.

usdyenAs to why this weakness is occurring, I leave you with a quote from Nordea Markets Strategist Martin Enlund:

“The Bank of Japan’s new framework is more significant than commonly appreciated. BoJ has voluntarily given up control of its balance sheet. Real rates will eventually plunge, prompting both bond sales to BoJ as well as JPY-negative outflows. Should more stimuli be required, the Japanese government has now been given a helicopterish carte blanche by the BoJ.”

The BOJ’s sole focus is to force investors out of the Yen and into other currencies. How do they do that? To quote from Martin Enlund again:

“With the BoJ’s intent to expand the monetary base as well as control the yield curve until inflation is “exceeding 2% in a stable manner”, it means real rates will eventually stabilise below -2%. As a result, domestic investors are likely to seek returns elsewhere and as a result sell JGBs to the Bank of Japan.”

Pretty simple eh? The BOJ has put a ceiling on long term interest rates, and abandons the ceiling on inflation, which hopefully results in much weaker domestic returns and forcing investors abroad. Or as Martin Endlund puts it:

“Furthermore,Japanese investors will likely need to take on greater credit- or currency risks, or both,”

The BOJ is forcing Japanese investors further out on the risk curve. Whether or not they will be rewarded for taking these risks remains to be seen. Yen dollar basis swaps are already deeply negative, further reflecting the high costs of converting one’s Yen into dollars.

The Yen remains a safe haven currency, and if the BOJ forces even more Japanese investors abroad, any financial shock could send those people right back into the Yen at a significant loss. The end result would be a stronger Yen, an unhappy populace, and a BOJ whose balance sheet is bigger than ever.

It’s incredibly hard to predict where this might go, but for now, it looks like the Yen has tipped its hand and is headed lower. The inverse of a weak Yen is a strong dollar, which spells bad news for gold, US treasury, and China bulls. If anything is clear, it’s that the boring summer is finally over!


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