It probably wasn’t the seemingly drunken appearance of the Japanese finance minister at the G7 meeting in Rome that toppled the Japanese yen, but the history books might record this weekend as a turning point for the currency. Several currency analysts have raised the question as to precisely why the yen remains a safe haven. Indeed in this column some weeks ago we questioned the life expectancy of the carry trade through which investors sold short lowly yielding yen for currencies with greater returns. It seemed to us that after six months into the yen’s rally that it must have been impossible for anyone short the yen to have not heard the five-alarm fire horns screaming from the fire truck.
Click on link for updated table throughout the week at HYPERLINK "http://www.interactivebrokers.com/en/general/education/FX-View.php?ib_entity=llc" http://www.interactivebrokers.com/en/general/education/FX-View.php?ib_entity=llc
Yesterday the global equity markets swooned to three-month lows but for the first time in a while it was the dollar that picked up the reins and led the currency pack. While the G7 met, mandarins at the department of finance in Tokyo were adding the final touches to one of the lousiest GDP reports in history. The Japanese economy contracted at an annualized rate in the fourth quarter by more than 12% with a rising yen adding insult to injured export-led weakness.
For sure the news is dire not just for the domestic economy given its natural implication for incomes and employment. But it’s also extremely dour news for Japan’s Asian trading partners. We noted last week that the Chinese government’s stimulus was effective in that lending through the banking chain was working thanks to few constrictions in the system. That contrasts sharply to efforts elsewhere in the globe where governments are facing a tough task helping local banks get back on to their feet dazed by recent implosions. However, the fact that China must resort to stimulating its economy highlights the interlinkages that have developed in the last cycle reliant upon consumers leading the way.
In Philadelphia options trading yesterday there was reasonably heavy volume on Japanese yen put options expiring in March. Customers amassed selling rights on the yen before expiration at the 105 strike. The XDN World Currency Option index is currently trading down 1% at 107.18 today and is fast approaching the strike price helping lift the price of the 9,000 or so puts bought yesterday. This morning investors continue to buy such puts whose option implied volatility at 17.5% is still not signaling any signs of panic ahead, although we have to raise the questions of what might happen should equity markets recover or if risk aversion leaves the value of the yen heading south.
WCO currency values are quoted inversely to the spot price and so the strike price is equivalent to a $/¥ quote of 95.25 compared to 93.39. Sure that doesn’t seem far away right now, but the dollar is fast recovering from a double-bottom formation on the charts at around ¥87.50. A clearance of roughly ¥95.00 for the dollar could leave it with a technical objective of ¥102.50, which would be a real boon to those put option investors.
As sure as the global economy needs a recovery plan, the Japanese need a weaker yen. It seems to us that investors have reached a point where the knee-jerk response of buying yen in reaction to lower equities makes no sense. The more they buy Japan, the more it slows down while another day of policy inaction goes by. The more Japan slows down serving contagion on its partners the greater the likelihood of a country or government debt downgrade. It’s almost perfect to offer the warning of ‘be careful what you wish for’ in that sense.
When the response to risk aversion is either insufficient or not forthcoming, the case for seeking refuge in one country’s unit of currency loses its path. That seems to be where we are in the case of Japan. The key going forward will be twofold. Is the U.S. dollar’s safe haven status likely to suffocate any policy response? Second, is the U.S. economy sufficiently flexible to handle currency appreciation and wear the mantle of the world’s reserve currency? Given that the apparent importance of the U.S. consumer who is predisposed to buying from abroad, a strengthening dollar would benefit the global economy. With export manufacturing weakness a given component of the domestic economy we can already guarantee that the emergence of recovery won’t be export led.
Andrew Wilkinson
Senior Market Analyst
ibanalyst@interactivebrokers.com
The material presented in this commentary is provided for informational purposes only and is based upon information that is considered to be reliable. However, neither Interactive Brokers LLC nor its affiliates warrant its completeness, accuracy or adequacy and it should not be relied upon as such. Neither IB nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results.
This material is not intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Securities or other financial instruments mentioned in this material are not suitable for all investors. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue. The information contained herein does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation to you of any particular securities, financial instruments or strategies. Before investing, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
