The Nikkei, Yen and Oil: Joined at the Hip

One of the more laughable charts since the election has been the Nikkei 225 (NKD), which has soared 2,600 points in the face of: (1) the election of a protectionist US president, (2) higher oil prices, and (3) higher interest rates.  Yesterday, it reached our next upside target of 18,631, which puts it roughly 25% higher since our Feb 9 bottom call [see: Update on NKD: Feb 9.]


When the Fukushima Daiichi disaster resulted in Japan’s nuclear power plants being shut down five years ago, oil and gas imports became even more critical to Japan’s energy needs.  Energy costs spiked higher, impacting consumers and businesses alike.

What wasn’t spiking higher was the Nikkei.  The correction in the summer of 2011 was turning into a rout.   Were it not for the yen carry trade [click for an explanation] and the floor the BoJ put under the USDJPY, we might well have seen the next leg down of the 2007-2009 crash.2016-12-01-nkd-v-usdjpy-2011-2015

Instead, the Bank of Japan — in coordination with the FOMC — crashed the yen.  It saved stocks.  But, as the yen plunged from 75 to 105 (per USD), Japan had a different kind of problem on its hands.  Rising oil prices (priced in USD) were being exacerbated by the yen’s plunging purchasing power.japan-energy-pxs-1014-09

The BoJ, which had used the threat of deflation as the rationale for unprecedented quantitative easing, found itself with increasingly noticeable and rather inconvenient inflation.

The only solution was to crash oil prices.  Other central banks, which were similarly committed to higher equity prices and, by now, understood the importance of the yen carry trade, were eager to join in.2016-11-30-usdjpy-v-cl-joined

This began a symbiotic relationship between USDJPY, CL and NKD that continues to this day.

  1. The day that USDJPY broke out of a lengthy consolidation in Aug 2014 was also the day that CL broke down.
  2. When USDJPY broke down on Feb 11, 2016, oil bottomed and began a rally that would see it double by October.
  3. USDJPY’s bottom on Jun 24 closely followed CL’s Jun 9 top.

The Feb 2016 role reversal was one that caught a lot of investors off guard.  I covered it extensively at the time [see: USDJPY Finally Relents.]  The entire oil complex, the banks which financed it and the countries which were supported by it were on the ropes.  The cheap yen was increasingly a problem.  It was time to put a floor under oil and crash the USDJPY.

By Jun 24, USDJPY had shed 20% and CL had gained 96%.  Algos loved (ok, were programmed to love) resurgent oil prices just as much, if not more, than they did the crashing yen.  And, of course, the steadily falling USDJPY (appreciating yen) made higher oil prices tolerable for Japan.


By now, you might be wondering what all of this has to do with…well, anything.  It’s very simple.

We called a top for oil on Oct 11 [see: Welcome to Peak Oil.]  We were rewarded with a 19% drop that has since rebounded by (a Fibonacci) 88.6%.  Yesterday, OPEC struck a deal which they insist will drive prices to new highs.  Putting aside, for the moment, the considerable hair on the deal, there are some serious problems with higher oil prices.

For one, central banks don’t need higher inflation in the same way they need higher stock prices [see: Japan’s Equity Trap.] They might say they do, and in certain cases it might even be beneficial.  But, higher inflation brings higher interest rates and the need to moderate ZIRP and NIRP.   Remember last year when the FOMC raised rates just a little?  Stocks didn’t like it one bit (NKD sold off 24% in under two months.)

With global debt having spiraled out of control over the past seven years, appreciably higher interest rates would put a serious dent in most countries’ ability to remain afloat.  The US government, for instance, with $20 trillion in nominal debt (much more off the books) faces a $200 billion hit with every 1% across-the-board increase.

Where, exactly, is that money supposed to come from?  Certainly, not courtesy of the lower tax rates Mr Trump has promised.  And, I’m not laying the blame at Trump’s feet.  The money is simply not there unless politicians take a huge carving knife to our current budget.


Japan, Europe, China…it’s just as bad, if not worse, everywhere else.  Higher rates are simply not acceptable.  Bernanke wasn’t joking when he said, in May 2014, that he didn’t expect interest rates to ‘normalize during [his] lifetime.”  So, one would expect central banks to continue doing whatever is in their power to avoid them.

This, of course, brings us back to the oil “deal” and why, even in the face of a rip-your-face-off rally in oil, we remain short SPX with our downside targets unchanged.

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