As oil prices continue to settle lower, the scrutiny of their fundamentals in the financial and popular press has intensified. There’s nothing wrong with fundamentals. Once in a while, they still matter — a nod to nostalgia, no doubt. But, we’re focused on technicals and the impact lower CL prices have on the overall “markets.”I have yet to see anyone else touch on one of our central research tenets: more affordable oil makes a cheaper yen more tolerable for Japan — one of the biggest oil importers in the world. And, as long as the yen — currently 124 to the US Dollar versus 75 in Oct 2011 — can be trashed even more, then the all-important yen carry trade is safe.
As we’ve shown countless times on these pages over the past year, the yen carry trade has been the single greatest factor in driving stocks higher.
When the yen stops getting cheaper in dollar terms, trillions in carry trade bets will unwind and stocks will sell off. So, it’s critical to the “market” that it keeps getting cheaper. And, because the Bank of Japan has rationalized their massive QQE with the “fact” that inflation is nowhere to be found, rapidly rising oil prices would be inconvenient.
As we detailed last March in Those Wacky Central Bankers, cheaper oil was the only way to make the puzzle pieces fit. After Fukushima, rising oil prices were becoming a serious impediment to the deflation spin.
The excellent Index Mundi shows the near tripling of oil priced in yen since 2008.Oil priced in US dollars, by comparison, was quite stable between 2011-2014.
In a move that would make even China blush, the BOJ has constantly intervened to prop up its own stock market. 2014 marked a potential turning point.
The April 2013 expansion of QQE had produced good results, but the trend was in danger of failing. Starting in January 2014, NKD began a series of lower highs, and even put in a couple of lower lows to match. As any chartist knows, this is a bearish sign.
So, the BOJ (which, unlike the US Fed, is honest about its intervention) simply picked a line (red dotted) and prevented NKD from dropping below it. This kind of intervention would later earn China widespread derision. When the BOJ propped up its “markets”, Wall Street cheered.
The BOJ kept the red triangle bumping along for almost 10 months. Finally, in June 2014, when NKD was backtesting the white channel and the red triangle top, it became obvious that something had to give. The BOJ needed NKD to break out.
It had been barely a year since the last round of QQE expansion, so they turned instead to direct currency manipulation. The yen had been strengthening against the dollar for 13 years: from 147 yen/dollar in 1998 to only 75 in 2011 (its 2011 low came on the exact same day as SPX.)
The QQE instituted in 2011 had devalued it to 105, which for USDJPY was a 61.8% retracement of its plunge following the financial crisis. It was also bumping up against the top of a pretty well-formed falling channel (below, in red.)
A reversal at this point (yen strengthing, USDJPY falling) would kill the carry trade. They needed a breakout, instead. The USDJPY chart below shows what happened next.
Stocks responded favorably, of course — especially after a further QQE expansion was announced a few months later. But, the BOJ had a problem. A cheaper yen makes imports more expensive. Fresh food, for instance, rose over 11% in the past year alone.
Oil, which is priced in US dollars, had already tripled from its 2008 lows. An even lower yen would be intolerable. Not only would consumers and producers take a hit, but it would be that much harder to keep a straight face when announcing more QQE in order to reach that magical 2% target.
The answer: cheaper oil.
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To learn more about how CL and USDJPY dovetail with our analog that has accurately delivered important turning points for the past several months, see: USDJPY Analog Charts. I’ve posted 2011 – 2014, and will be posting the final charts today.