Japan has a problem. And I am not talking embarrassing prom date kind of problem. Japan has lost their ability to keep the Yen down, and in doing so, all of Kuroda’s hard work is coming unraveled.
In mid-January when Japan surprised the market with a move to negative rates (Expert Liars), the Yen had an initial small sell off. However, since then, the Yen has been steadily climbing.
For a while the Japanese stock market seemed to weather the storm, but recently the Yen strength has become too much to bear. For the past week it has been almost straight down for the Nikkei.
Last night, the Japanese stock market once again led the world’s stock markets lower with another 3.2% sell off. This sort of ugly decline is becoming all too common.
In the meantime, Kuroda desperately tries to jawbone the market higher. Yesterday speaking in Parliament (from Marketwatch):
…Kuroda reiterated his stance to “undertake additional monetary easing without hesitation” if necessary, either by increasing the central bank’s asset purchases or by lowering its deposit rate further below zero, or both.
This morning as I write this there are Reuters’ headlines going across the tape that show an increased concern from BoJ officials:
07:50:08 AM RTRS - IF BOJ WERE TO ACT, MORE LIKELY TO INCREASE ASSET BUYING THAN FURTHER CUT INTEREST RATES - SOURCES
Cannot afford a higher Yen
Although the Yen is dirt cheap, the Japanese simply cannot afford a higher Yen. In this low growth world, they are least able to withstand an appreciating currency. Japan needs to continually steal all the growth they can from the rest of the world. Even three months of a rising currency is too much for them to handle.
That’s why as crazy as it sounds, the Japanese will increase their monetary accommodation. There is no turning back for them. They cannot grow out of the problem. And defaulting is not an option. Nope, it is full steam ahead. Come hell or high water, the Japanese will monetize their crazy amount of debt. It will be paid back, just in extremely depreciated Yen.
The higher the Yen goes (and by extension the lower the Nikkei plunges), the more aggressive the response will be from Kuroda.
Carry trade unwinds
It is impossible to know how much the Yen carry trade has affected risk markets over the past few years, but there is no doubt it was a big driver. All you need to do is look at the hedge fund index performance versus the Japanese Yen to realize it was a significant factor:
If the Yen continues to appreciate, it could cause a significant unwind of the carry trade. I am not sure if the long term money is close to panicking, but I don’t think any Central Banker wants to see this trade come off quickly.
Buy some Yen vol
In this environment you would expect Yen implied volatility to be pushing near the highs. To my surprise Yen vol has not moved that much over the past couple of weeks. Have a look at the 3 month at the money volatility chart:
Vol is up, but not that much. To me it seems like a great risk reward long trade. The USDJPY rate is breaking down, and the BoJ is increasingly concerned about Yen strength gathering self reinforcing momentum. I am not sure how it will play out from here, but I doubt it will be orderly.
It’s time to be worried about Japan. They need to ride to the rescue to keep this grand experiment from coming unglued. Keep your eyes peeled on Kuroda and the gang…
Thanks for reading,