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The Japanese yen continues to defy its own economic fundamentals. It continues to move up and down in value, in correlation with “risk off” (stocks and growth assets moving lower) or “risk on” (stocks and growth assets moving higher). But the latest statistics and dynamics driving the Japanese economy into the future still tell me the yen will weaken in a very big way, sooner or later.
If you are a long-term player who has some patience, I consider this the best single trade setup among the major foreign exchange pairs: A core long-term long position in USD (U.S. dollar)/JPY (Japanese yen). In other words, bet that the yen will fall in relation to the dollar.
Of late, the yen (relative value) is moving in tight, negative correlation with risk assets. Using the Dow Jones Industrial Average (DJIA) as a measure of risk assets, you can see that as the Dow falls, the value of the yen rises. On the chart below, the USD/JPY falls as the yen gets stronger relative to the U.S. dollar.
Whether you consider the yen correlation against the DJIA or the Nikkei 225 Index, it is effectively the same — concern in global stock markets means the yen strengthens. The primary reason is simple repatriation.
Japan is still a very wealthy country despite the economic calamity experienced since the bubble broke back in 1989. Its insurance and pension funds have vast amounts of investment capital. When things get ugly globally, measured by stock markets, these big pools of funds tend to rush back home to hide in local Japanese government bonds for safety.
However, this theory that weakness in stocks consistently means a strengthening yen, one I have discussed before, doesn’t hold water if you change your perspective to the long term.
For example, consider the relationship between the DJIA and USD/JPY going back to the credit crunch period beginning in mid-2007:
- DJIA down 15.2 percent from its peak
- USD/JPY down 35.9 percent from its peak
Dollar/yen has fallen 35.9 percent, or put another way — the yen has strengthened 35.9 percent against the U.S. dollar since the credit crunch (creating huge price pressure on Japanese exporters) while stocks rose.
And when you consider that one of the major impacts of the credit crunch was the decline in global demand for goods from export-oriented countries, such as Japan and China, you can see why Japanese companies are screaming for relief from this double whammy of pain.
Japan’s Soaring Government Debt Crisis
The dangers of a declining trade surplus and strong yen pressures are put quite clearly into context when you understand that Japan will likely run a fiscal deficit of a whopping 10 percent of GDP. Meanwhile its debt/GDP ratio could rise to the moon-launch level of 241 percent (roughly twice the level of Italy) this year, according to forecasts by the International Monetary Fund.
Notice in the chart below how government debt has continued to ramp up after the bubble broke in 1989. And this fits the view gaining ground that after Mr. Market is done crushing the European bond market, it turns its guns on Japan.
Now, what makes that picture even worse is the train-wreck scenario of Japan no longer being able to fund these huge debt needs internally as the pools of private and business savings are drying up. In other words, if Japanese interest rates rise from their incredibly low levels — 0.89 percent on the 10-year Japanese Government Bond (see chart below) — the cost of funding with 200+ percent debt/GDP could shoot up exponentially.
If Japan’s bonds begin to reflect real or even potential funding risk, forcing interest rates higher, it means that local demand from Japanese institutions will fall even more, putting greater pressure on rates, while the slowdown in economic activity will further reduce Japan’s available pool of savings to fund this growing need.
Japan is facing a very scary situation here. Sooner or later, the yen will begin to reflect these internal realities. I think it will be sooner. When it does, the value of the yen has a very long way to fall (USD/JPY has a very long way to rise). The long-term profit potential I see here is enormous.
Best wishes,
Jack
P.S. Earlier this year, my World Currency Trader members stood to pocket a 47.4 percent gain with a USD/JPY trade. Plus they’ve been given two other recommendations that have the potential for even bigger gains! Click here to see how you can join them, RISK FREE.
