Regular readers know that I’ve been beating the carry trade drum for years. From 2011 to 2015, it was the yen carry trade driven by the plunging yen (rising USDJPY) that was largely responsible for stocks gains. I wrote about this most recently (Feb 22) in our latest post on the Big Picture. 
At the end of 2013, stocks were in limbo when USDJPY ran into serious technical resistance — the top of a falling channel from 1998. Japan also faced fundamental problems because oil, priced in USD and topping $110/barrel, was causing rather inconvenient inflation (remember, Japan’s nukes were taken offline following Fukushima.)
It’s tough to justify historic accommodative measures in the midst of nearly 4% inflation. But, the BoJ, very much stuck in an equity trap, dared not change course. Withdrawing QQE was not an option.
Stuck between an inflationary rock and a market crash hard place, USDJPY spent eight months going sideways — coiling, but never breaking down — until it finally broke out of the falling channel on Aug 20, 2014. The yen plunged in value, which might have sent inflation spiraling higher.
But, two days earlier, oil had broken down through long-term support. And…spoilers: it was not a coincidence.
USDJPY rallied sharply, gaining 22% by June 2015. And, CL dropped like a rock, losing 55% by Jan 2015 and, of course, much more after a couple of bounces.
The sharp drop in oil obviously made the plunge in the yen palatable. Inflation dropped back below 2% in early 2015 (below zero by 2016) and SPX rallied past the resistance du jour to new all-time highs.
Everything was going well until USDJPY, reached 120.11 — a critical Fib level which represented 61.8% of its drop from 147.65 in 1998 to 75.65 in 2011. Itt spent 14 months playing cat and mouse with 120, boosting stocks with every push above and triggering sell offs like with every dip below.
There was one such scare in August 2015, when USDJPY broke trend and ultimately dipped below 120. SPX, which had recently reached what we deemed a top [see: The Last Big Butterfly], plunged 12.5%.
USDJPY pushed back above 120 and stocks recovered. But, it didn’t last. In December, It fell through 120 again. This time, stocks plummeted 14.5%. Clearly, something had to give.
Fortunately for stocks, CL was nearing a bottom. I had had a downside target of 26.22 on CL since Jan 9 and called a bottom on Feb 11 simply because any further drop in CL and USDJPY would have broken some very long-term trend lines for SPX [see: USDJPY Finally Relents.]
Oil bottomed at 26.05 on Feb 11, and rocketed higher, almost doubling in 4 months. Its recovery was about all that stocks (well, algos) cared about. When CL finally reached 51.6 last October 10 — one year from its last 2015 peak — I called a top [see: Welcome to Peak Oil.]
It occurred to me that oil would need to decline sharply over the next 4 months or Yellen & Co. would also be facing some rather inconvenient inflation of their own.
As it turned out, that call was premature. CL fell 18%, but the drop was tough on stocks — which everybody wanted to ramp higher into YE, especially after the near disaster on election night [see: The Fallout.]
So, the decline was postponed until 2017 — with CL putting in a high on Jan 3. It might have stayed at that level, too, but for inflation. January’s 0.6% MoM (2.5% YoY) CPI sent shock waves through the Eccles building — not to mention the bond market.
With February’s (probably worse) numbers due out on Mar 15, central bankers must take action to avoid being painted into an inflationary corner. Bottom line, this is the swoon we’ve been waiting for.
There are two ways to play it, and neither of them involve stocks. CL has already reached our two initial downside targets, but there is more to come.
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