An Offer Japan Can’t Refuse

godfatherI’ve written ad nauseam about the importance of the yen carry trade to the stock “market” since October 2011.  Put simply, a rising USDJPY (weaker yen) lifts stocks.  A falling USDJPY causes corrections.  It’s really as simple as that, though there are plenty of nuances.

Yen Carry Trade PictureOne of the most important nuances is the price of oil which, to a country like Japan that imports most of its energy needs (even before it shut down its nuclear plants), is driven higher by a weaker yen.

Higher oil prices cause undesirable inflation, which further pressures struggling Japanese taxpayers – both corporations and individuals.

One of my more outlandish theories advanced back in March [see: Those Wacky Central Bankers] suggests that oil’s price crash over the past year was engineered in order to induce Japan to further weaken the yen.  The chart below clearly shows that oil broke trend line support at exactly the same time (August 19, 2014 – the white arrows) that the USDJPY broke out from an 8-month old triangle.2015-09-01 USDJPY v CL 2014 breaks

As everyone knows, correlation isn’t causation.  But, suppose the BoJ were hesitant to visit more inflation on their citizenry.  Wouldn’t the promise of a 2/3 drop in the price of oil help grease the skids?

Keen market observer Eric Hunsader of Nanex has frequently written about the spoofing going on in the oil market.  Spoofing involves placing and quickly cancelling a barrage of orders — usually within a fraction of a second — in order to convince market participants that a certain depth of buy/sell orders exists.

One instance on January 9 [reposted on Zerohedge] detailed 69 100-lot orders spoofed during a 45-minute period.  Suffice it to say, it’s no more difficult to manipulate the oil market than it is the stock market.

When USDJPY reached the .618 Fib at 120.11 (its most serious overhead resistance) in December, it faltered.  Per the rules of Harmonics, a reversal would have been normal after recovering 61.8% of its drop from 147 in 1998 to 75 in 2011.2015-09-01 CL v USDJPY daily recapOn Dec 5, the day that USDJPY reached 120.11, SPX began a 107-point (5%) drop.  The drop bottomed out on Dec 15, which not so coincidentally is the day that USDJPY reversed and headed back to 120.11.  Guess what else happened?

Gold stars for everyone who said “oil dropped again.”  In fact, it dropped another 18% over the next 3 months.  On the day that we called the bottom in oil [see: Update on Oil Mar 17, 2015] USDJPY committed the faux pas of dipping back below 120.11, and failing to recover until mid-May.

Stocks didn’t much care for this irresponsible behavior, so they did the same – bouncing sideways until USDJPY topped 120.11 again, in a halfhearted and quick-to-fail bounce that couldn’t overcome the huge Butterfly Pattern [see: The Last Big Butterfly] completion at 2138.04. 2015-09-01 SPX v USDJPY daily recap

SPX maxed out at 2134.72 and it’s been all downhill since.  As the chart above shows, things have gotten especially ugly each time USDJPY dipped below 120.11 (as well as key moving averages.)  Today’s cratering was the latest and greatest example.

But, the S&P 500 isn’t what keeps Haruhiko Kuroda awake at night.  It’s the $666 billion equity portfolio that’s concentrated in Japanese stocks that, between them, the BoJ and GPIF own.  It’s about 14% of Japan’s GDP.  So, when the Nikkei was off by 18% ($120 billion) from its highs last Monday, Haruhiko was staring down the barrel of a 2.4% GDP haircut. [see: Japan’s Equity Trap.]

Odds are, the prospect of that kind of loss got his attention — just like the 31% increase in oil prices over the past week did.  Energy imports were about 55% (about $70 billion) of Japan’s trade deficit over the past year.  That 31% increase, were it to hold, would equate to roughly $21 billion — an ongoing 1/2% hit to GDP.  Another tax, as it were.2015-09-01 CL dailyClearly, Abe and Kuroda are faced with some tough choices:

  • devalue the yen further, keeping the yen carry trade alive and saving their massive stock portfolio (not to mention their jobs)… but, at the cost of much higher energy expenses for businesses and consumers
  • let the yen appreciate, and thereby keeping energy costs affordable…but, at the cost of massive losses in the markets

Luckily for them, they have friends like the Fed, the ECB and the BOE who are more than willing to help.  Suppose, for instance, the other central banks came to them with a third option?

Suppose they offered to help keep oil affordable…as long as Japan did its part to keep the yen carry trade alive?

Sure, Mrs. Watanabe will pay more for fresh food, but at least her stock portfolio won’t go all Fukushima on her.  And, government employees might even be able to collect a little something from the GPIF come retirement time.

It’s not a permanent solution, as Japan is technically bankrupt and this only postpones the inevitable.  But, that’s what central bankers do best, right?   If Japan can’t do the right thing, well…we might just have a few more days like today.  And, that would be a shame…

In my opinion, it’s an offer Japan can’t refuse.



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