Currency traders are well aware of the spectacular advances in USD/JPY since last autumn: Rising 23% between October and March to hit four-year highs, posting six consecutive monthly gains and attaining the longest string of uninterrupted monthly advances since 2001. Does the rally have more legs? Traders have mentioned 97 and 100 yen. But how about 105 or 120?
Reflating the Nikkei 225
The soaring USD/JPY has been the result of newly elected Japanese Prime Minister Abe’s aggressive policy to reflate the economy by breaking the vicious cycle of deflation, which prevailed in six of the last ten years. Abe forced the Bank of Japan to increase its inflation objective to 2% from the current 1%-2% range and vowed unlimited bond purchases to reach the new price objective. Abe is expected to win the elections in the upper house of parliament in July, which should bolster support for his spending policy and further lubricate Japanese equities and drive down the currency.
The Nikkei 225 Index wasted little time to rally on the promise of cheap money and falling yen. In 2012, the Nikkei 225 rose 23%, posting its biggest annual increase since 2005. Despite these rapid gains as of late, the Nikkei 225 increased only 56% from its 2008 cycle lows to mid-March. This compares to 126%, 115% and 117% for the S&P 500, Dow Jones Industrial Average and the Dax-30, respectively, from their March 2009 lows to mid-March 2013. Considering Japan is at an early stage of an aggressive easing policy, the Nikkei’s upside may just be getting started.
On the U.S. side of the USD/JPY, there stands a win-win situation for the pair. In the unlikely event that the Federal Reserve signals a tapering in its asset purchases, then the U.S. dollar may get a broad boost on restricted liquidity. If on the other hand, the Fed maintains the $85 billion in monthly purchases, then the JPY may remain pressured as liquidity is set to support equities and overall risk appetite.
On the speculative side, positioning in USD/JPY shows a negative 73,351 contracts, which is net short JPY vs. the USD. Although such positioning is the biggest JPY short in nearly six years, it remains well below the 188,000 record attained in June 2007 when USD/JPY stood near 124.00.
U.S. jobs argument
The improvement in U.S. employment figures will likely remain a principal driving force in USD/JPY. American non-farm payrolls were near the same levels of +200-300K seen in summer 2007. But two key differences stood out: The 3-month moving average remained stable around the 130,000-190,000 range over the last two years, while the 3-month average in 2007 stood near 80,000, well below the 250,000-280,000 range prevailing between 2005 and 2007. This illustrates that the ascent in job creation over the last two years is clearly superior to that when equities had peaked in 2007, suggesting the rising trend could feed into higher personal expenditure and corporate margins.
Moving on to U.S. manufacturing jobs, we find their 3-month moving average currently stands at 14,000 in March, compared to a range of -15,000 to -30,000 jobs prevailing in 2007. Not only was the 2007 plateau in manufacturing spread at far lower levels, but it lasted for about two years before giving in to the 2007-2009 economic collapse.
The above analysis illustrates that U.S. labor markets currently are undergoing healthier flows (rates of change) relative to those in 2007 when equities were at record highs. Although the jobless figures are higher in absolute terms (higher unemployment and jobless claims), their rate of decline remains fluid. And with the Dow Jones Industrial Index the only one of the seven major global indexes to be at record highs at the time of this writing, the scope for further gains by the Dow and other indexes to catch up is inevitable considering these brightening U.S. fundamentals.
USD/JPY perfect storm
USD/JPY remains the perfect storm as it is propped by : 1) Full-fledged anti-deflation Japanese policy; 2) improving U.S. growth dynamics; and 3) broadening global risk appetite further weighing on the yen. Knocking all of the major weekly moving averages out of sight, USD/JPY faces the next barrier at the 100-week moving average of 98.40. The next objective would be at 101.20/50 — the base from autumn 1999 and winter 2005. Noting that the 100-month moving average was last breached at the same time the 200-month one was broken, 108.00 may be a realistic target. The key for USD bulls remains the extent of the next corrective pullback before renewing the gains. USD/JPY support will need to hold at 86.50 for the current rally to continue. But the road to 108 appears to carry sufficient policy backing.
Ashraf Laidi is chief global strategist at City Index-FX Solutions and author of “Currency Trading & Intermarket Analysis.” His Intermarket Insight appears daily on AshrafLaidi.com