Ralph Shell @ 1:05 PM, Friday November 19 2010
Considering the size of Japanese public debt combined with the financial worlds recent aversion to debt, and the prospect of a weaker economy, partly because of reduced demand from a rapidly aging population, the strength of the yen has been a conundrum. Riding the yen's appreciation, the large spec traders in the futures accumulated a healthy long. The recent trend reversal has resulted in long liquidation, and has continued this past week. The USD, versus the yen traded slightly above 80, but has rallied in the last three weeks to 83.77.
Part of the USD strength has probably been short covering by overzealous shorts, however economic news from Japan remains worrisome. Earlier this week it was reported the GDP grew at a better than expected 0.9% but according to the Daily Yomiuri Online, they say:
"that sunny figure does not reflect the rather more gloomy reality of
the current economic situation.
The growth was primarily due to temporary factors, such as a
last-minute rise in demand for cars before the end of government
subsidies for eco-friendly models and the unusually hot summer, which
drove up consumption of durable goods such as air conditioners.
The prevailing view is that the GDP will post negative growth in
October-December, with private consumption falling and exports
struggling due to the yen's appreciation against the dollar."
Japan has been fighting deflation for years, as they have unsuccessfully tried to reflate the speculative real estate bubble that broke 20 years ago. Taking heavy doses of the Keynesian medicine, Japan has borrowed heavily for public spending projects, accumulating massive debt. Following the lead of Bernanke, the Bank of Japan is about to embark on their version of QEII, again in the name of fighting deflation. There is little reason to think they will be successful but the market is aware of the Japanese problems and is incorporated in the price.
There are some issues that may weaken the value of the yen in the intermediate future. Confirmation that the strong yen has hurt exports, and the GDP, going forward is one reason. Using the strong yen to make overseas business acquisitions, and borrowing in Japan for nothing and lending offshore, would also result in yen selling. What happens though if we measure the value of the yen not in dollars but against the euro?
The bankers currently meeting in Dublin are involved in high stakes, trying to preserve the euro and their financial world. What would the cost be of unraveling billions of bank loans in ten or more currencies rather than the single currency. The cost of an Irish bail out may be high but what is the cost of no bail out if the euro implodes?
The euro and the yen have been trading in a range of 1.1103 to 1.1560 since the middle of September. This pair has formed a pennant with a break out to the bottom under 1.12. Currently we are trading at 1.14, and a close above 1.1440 would be a break above a downtrend line that goes back to April. The MACD is flirting with a cross over around the zero line. Should we break to the upside, an objective of 1.20 is initially possible.
Author: Ralph Shell - ForexRazor Analyst - Graduated from a small Ohio liberal arts college. Graduate studies in economics and history at Duke University. Ten years experience trading cash commodities in domestic and export markets. Former commodity analyst with Merrill Lynch in Chicago. Member of and floor trader at the Chicago Board of Trade for 18 years.