When Bank of Japan Governor Kuroda stunned the market a couple of weeks ago by foregoing any increased quantitative easing, the firm with the most egg on its face was Goldman Sachs. In the days leading up to the meeting, Goldman had been pounding the table with a recommendation to short Yen as they believed Kuroda would have no choice but to over deliver already inflated expectations. This aggressive call by such an influential firm only made the market reaction to the surprise decision all the worse.
We all make bad calls, and I was as surprised as Goldman by Kuroda’s decision. In the aftermath of the stunning BoJ pass I suggested the market was vulnerable to worsen as Japan had entered their “Golden Week” holiday. Goldman not only pulled the rip cord on their long USDJPY (short Yen) call, but then stated USDJPY would continue to fall:
Our view going into last week was that the BoJ needed to grab the bull by the horns and dispel the notion that it is running “out of bullets.” We thought it could do this by shifting the emphasis back to balance sheet expansion by, for example, taking concrete steps to lift housing loans off banks’ balance sheets, something Governor Kuroda floated in a recent speech. Instead, the BoJ seemed intent on teaching the markets to be “patient,” downgrading the inflation forecast yet again while taking no action. This is a fateful miscalculation in our view. Unconventional easing is above all an expectations game, where it is necessary to shock markets again and again, until they have no reason to question a central bank’s commitment to its inflation target. Preaching “patience” is the opposite, telling markets they expect too much. There is little doubt in our minds that $/JPY will keep falling in the near term, until Governor Kuroda is forced to respond with overwhelming force. We therefore hold to our structural view that $/JPY ultimately will go a lot higher. But in the short term, it will fall.
This was capitulation at its finest. Not only did they give up on their short Yen call, but then made it worse by succumbing to price momentum and forecasting the new trend would continue. Not only that, but this was directly opposed to the fundamental direction Goldman believed the Yen was headed. Mopes! Glad to see we all flail about occasionally.
As the Japanese holiday wound down I suggested the BoJ would not stand for the currency appreciation. I thought pro-risk Japanese positions made sense, and I was lucky enough to not worsen my previous error ala Goldman.
I still hold the view the Japanese will keep printing until they get their much desired inflation. Although amongst the hedge fund community it has now become popular to buy Yen on the idea the Bank of Japan has hit the wall and can no longer weaker the Yen, I think that is a terrible trade.
From a sentiment point of view, this trade is so crowded, it won’t take much for the BoJ to cause a stampede to the exit.
After being significantly short since the advent of Abeconomics, speculators have completely reversed and have pushed net Yen long positions to the highest in 7 years. And this is at a point where the Yen has already appreciated from 126 down to 106.
It’s not like Japan has stopped QE. They have simply not expanded it as much as the market was hoping. The BoJ is still aggressively expanding their balance sheet. When we examine the base money ratios between the US and Japan, it still continues to forecast a weaker Yen. Have a look at this chart which was a Soros favourite:
I am short Yen and long Nikkei. I see no reason to change that opinion. The hedgies are all leaning the other way, Goldman has puked out their position at the bottom, and no one believes the Bank of Japan will be successful in creating inflation. I don’t believe any Central Bank is powerless to create inflation, it is only a question of will. And the Bank of Japan is the most determined Central Bank out there.
I don’t think Japan’s long term problem will be a strong currency and deflation. In fact, given their policies, I suspect it will be the exact opposite. In the mean time, this seems to offer a great opportunity to get back into the short Yen trade.
I remember someone asking Kyle Bass what his favourite trade was for the next decade. He responded long gold denominated in Yen. I couldn’t agree more…
Thanks for reading,