Its not often that a macro breakdown of this magnitude presents itself, but Dollar/Yen is providing the opportunity to monitor and learn from just such a breakdown in real time.
One of the more interesting mysteries of the last two decades has been the durability of the JPY.
- Years of extremely accommodative monetary policy , Negative Interest Rate Policy (NIRP), Yield Curve Control (YCC) and Quantitative Easing ( QE ) have thoroughly disrupted fair value across JPY asset classes.
- Government Debt at 266% of GDP is more than double the threshold above which countries are vulnerable to sovereign default. For more on sovereign debt levels see Reinhart and Rogoff This Time is Different, Eight Centuries of Financial Folly. A must read in my opinion.
- They are an island nation devoid of energy assets. Higher energy prices increase the need for to swap Yen for Dollars in order to transact.
While monetary policy has created the greatest macro danger, growing yield differentials and rising oil prices represent more immediate concerns. In particular, the YCC policy that pins Japanese 10 year rates at 25 bps even as rates are rising sharply across the rest of the developed markets is creating massive capital outflows.
The YCC policy creates an arbitrage between Japanese and other DM rates.
- A Japanese citizen can swap JPY for DX and buy a 10 year US Treasury at +300 bps carry advantage.
- While collecting 300 bps in positive carry they own a currency ( DX ) far less likely to depreciate. Particularly as the Fed is tightening policy relative to the BOJ.
- If DX appreciates, they can add the appreciation to the carry.
This same dynamic can also be seen in institutional flows. With the yield differential so wide, the Yen Carry trade popular prior to the financial crisis is being implemented again. Investors can borrow Yen at very low rates, swap for higher yielding currencies and earn the carry. Many of us old guys remember the extreme pain generated by the unwind of this trade.
This arbitrage results in significant outward bound capital flows but in spite of the Yen weakness the BOJ continues to reiterate its support of the YCC program. It should also be remembered that the BOJ and other official Japanese institutions have acquired so much of Japans sovereign float, that even if they lose their resolve and end YCC, rates probably won’t rise enough to totally offset the rate differential. I suspect that a rally with this as a fundamental catalyst, while violent, would likely fail long before reversing the recent damage.
Importantly the fundamental pressures add weight to the technical breakdown occurring on longer time frame charts.
- JPY/USD is breaking out of a wide, upwardly slanting channel that has acted as support for over 30 years.
- After testing the bottom of the channel, the market was unable to attract buyers and moved mostly laterally along the channel bottom. This lethargic behavior suggested a near complete lack of buying pressure/interest.
- The six years spent moving laterally stored tremendous energy. Remember that the more time spent in a range, the more potential for movement exists. In essence, six years of buyers are now trapped. I would expect that these trapped buyers will now be sellers into strength and drive declines.
- Wyckoff called this stored energy cause or count. The size of the count directly relates to the size of subsequent move as it reflects years of positioning, much of which must be adjusted for a new price regime.
- While I havent done so for this piece, Point and Figure counts can be used to derive targets based on the width of the count. You can see an example of how this is done on the IWM post linked below.
- The width of the channel (MM1 – MM2) can be projected lower (MM3) to arrive at an initial estimate of the potential move. This could create a measured move target as low as .003.
- There is a monthly perspective MACD sell signal. The solid sell signal comes after multiple years of what I think of as flutter (I think George Lane first used the term to describe the behavior in his stochastic oscillator).
- Following periods of oscillator flutter, a clear oscillator buy/sell signal coupled with a clear violation of price support/resistance can be extremely reliable.
In shorter term perspectives the market would normally be considered oversold (both price and momentum). But breakouts from large macro ranges attract strong handed sellers and often oscillators and price both behave differently than they do in normal markets. This is particularly true in the early in the move. Specifically, oscillator readings become meaningless and short term price targets are regularly exceeded. This makes them extremely difficult and risky to trade in.
At this point, to turn on JYPD will require the development of overtly price and behaviors or clear bottoming behaviors. Until then I will treat this as a bear market and use strategies and tactics appropriate for that environment.
Stewart Taylor, CMT
Chartered Market Technician
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