The U.S. Dollar-Yen (USD/JPY) Showdown

RemixTrades

The Japanese Yen is the new Swiss Franc. As the threat of a Japanese central bank intervention has taken over the market, retail traders have started to go short the Yen in large crowds. The SWFX Sentiment Index, a simple indicator of retail investor positions, shows that 80% of investors are short the Japanese Yen. While the $USDJPY is making fresh 2010 and 15-year lows below the 84.70 level, the contrarian sentiment indicator suggests that more losses are to be expected.

The hope of BoJ (“Bank of Japan”) intervention is nothing new and reminds me of a recent storyline in the FX markets. All through 2010, investors had been short the Swiss Franc and long the Euro (thus long the $EURCHF cross) as many believed that an intervention by the Swiss Central Bank grew larger by every upside pip in the Swiss Franc currency. As 2010 progressed, the interventions by the Swiss central bank did occur yet they were useless. Short-term spikes in the $EURCHF cross were quickly followed by downside retracements. Overall, the pair still reached the 1.30 handle after billions of Swiss Francs were used for central bank intervention.

The moral of the story is simple: intervention is unlikely to change a strong market trend supported by fundamentals. As a result, taking opposite positions after an “intervention” appears to offer the best risk-reward trade. Retail traders have lost substantial sums of money in 2010 by going long the $EURCHF in the hope of a big intervention-led reversal. Committing the same error with the $USDJPY cross is not recommended.

The fundamental factors supporting the lower $EURCHF were the European sovereign crisis and slower global growth. Lower yields in the U.S. Treasury market (with the 10-Year as a proxy) and global bond markets have been one of the main drivers of the Japanese Yen strength and the U.S. dollar weakness. It also appears that the trend is not likely to change anytime soon as bad economic data continues to dominate markets.

The common mistake by retail investors have been to believe in what I like to call “the big bottom”. In the current case, it is the idea that  bond yields ‘cannot go any lower’, which is similar to the belief in 2008 that the S&P 500 could not possibly go any lower than 1,000. This type of thinking can be pervasive and detrimental to short-term traders. Remember, bond yields can reach zero. I’ll repeat, the number stated was zero. While that may not happen, 2% on the 10-Year could happen. The same applies for 1%.

Click on image for larger chart of 10-Year Treasury Notes Futures

And don’t forget about Japan. It’s been quite some time since the era where shorting Japanese bonds were the “big trade”. Yields had “nowhere to go but up”. We are witnesses that it has been decades and deflation has kept Japanese yields near all time lows.

If the same faith applies to the U.S. economy, do you still believe $USDJPY at 79 is not reasonable?

Don’t bet on intervention. Bet on the data. Additionally, when something “cannot happen” in financial markets, it appears to become a reality.


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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