For those who are new to the concept, the yen carry trade has been around for a while and is fairly straight-forward. Borrow in yen at near 0%, invest in higher yielding instruments such as US treasury bills and pocket the difference. The only risk is that the yen would appreciate against the invested instrument’s currency, and one might face an FX loss when closing out the transaction.
When the BOJ announced they were going to cheapen the yen into oblivion, everything changed. Investors suddenly didn’t have to worry about the currency risk; instead, it would be a currency gain. They also found a more lucrative place to invest the proceeds of their borrowing: equities.
Since the BOJ also decided to prop up the Nikkei, investing the proceeds into Japanese equities became less risky. And, when the Fed jumped on board with the Bernanke (and now, Yellen) put, US equities became more of a “sure thing.”
Today, we see tick-for-tick increases in US equities every time the yen dips (and USDJPY spikes.) The correlation has been around 96% since the mid-October swoon. The only times we see divergence between USDJPY and ES are when USDJPY dips precipitously. But, then, there are other means with which to prop up ES, such as VIX. USDJPY often “resets” after the US cash markets have closed (it’s done its job for the day by levering ES higher) lest it sail right off the top of the chart.
As long as the yen continues to cheapen, and central banks continue to intervene in equity markets (directly and indirectly) the yen carry trade will continue to work.
Abe has shown little interest in throttling back Japan’s QQE, even in the face of mounting criticism from households and businesses alike (cheaper yen = more expensive imports, especially food and fuel.) In fact, the latest decision to expand QQE on October 31 is considered by many (including yours truly) as a desperate last gasp of policy which has clearly not managed to invigorate the Japanese economy.
Having said all that, we can at least identify key levels at which any remaining market forces might be expected to exert themselves.
First up is the .618 at 120.11. This should be a major Fib level — 61.8% of the huge drop from 147 in 1998 to 75 in 2012. Reversing at it would be bearish for equities. Slicing through it, as has occurred with several previous Fib levels, would be quite bullish.
Note that it intersects with a channel top connecting the Mar 2011 (Fukushima) and May 2013 highs — each of which preceded a decent sell-off for SPX (22% and 5% respectively.)
Will it sell off? Again, Abe & Kuroda seem to be hell-bent on running the yen into the ground. The Oct 31 surprise was a sign of desperation, a last gasp effort to turn things around that will almost certainly not work. Thus, they are fairly likely to continue overriding any pressure from rational investors.
With the end of the year coming up, I suspect we’ll see USDJPY barely pause at 120.11, but instead come back to backtest it — maybe even slipping below in the backtest. Whether they can keep the scam alive after year-end, I can’t say. But, there is little in the way of resistance other than the top of the tight, white rising acceleration channel the pair has been in since early November.