The Land Of The Sinking Sun

FT
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As the world lurched from credit crunch to a full blown economic recession, Japan’s status has transformed from a non-toxic safe-haven to an export-dependent crippled economy. What went wrong?

The Rise And Fall Of The Yen

For the past year the Japanese Yen has been the daddy of the major currencies; buying Yen was the proxy for risk aversion, even more so than gold, which suffered when hedge funds needed to raise funds urgently.

Japanese banks were judged to have been less exposed to the worst excesses of toxic loans. This implied that the domestic economy wouldn’t suffer as badly from the consequences of the credit crunch.

Further, as the global situation worsened, traders closed out carry trades on a grand scale; this meant selling high-yielding currencies like Sterling, the Euro and Aussie and Kiwi Dollars and buying Yen.

From last August to mid-January the Yen rose by 19%, 30% and 42% against the Dollar, Euro and Sterling respectively. Since then it’s lost roughly 10% against the Dollar and Euro, and 15% against Sterling.

Strong Yen over as Japanese economy collapses

This latest Yen weakness was against a background of renewed panic in equities (previously a case for buying the Yen) so what had changed?

1) Economics
In part, Japan was cursed by its own success. Over the past decade Japan had become more reliant on its export market. But then the export market changed rapidly. Firstly, consumers around the world were more concerned about whether they would have a job than buying a new Toyota. Secondly, the steep rise in the Yen was making Japanese goods even more expensive to overseas buyers.

In December Japanese exports fell off a cliff, dropping 35%, but this was even dwarfed by January’s 46% fall in exports, the biggest drop in 40 years. This reflected a collapse in demand for new cars, machinery and electronics.

In January the car-makers announced wholesale cutbacks, with Toyota cutting output by 43%. The jobless rate in December rose to a 41-year high of 4.3%, though this improved slightly to 4.1% in January. Industrial Production fell 30% on last year, and get this; growth in the final quarter fell by 3.3% – no, that’s for the quarter. The annual rate was a staggering -12.7%.

2) The Stock Market
Perhaps investors in the Nikkei (^N225) had more foresight than the currency traders, because the stock market got a bigger roasting than all the other majors. The index has fallen by 60% from July 2007; compare that to -51% on the S&P 500 (^GSPC) and Dax (^GDAXI) , and 43% on the FTSE (^FTSE).

This has led to Japan’s own banking crisis. Japanese banks have large portfolios of domestic shares in their portfolios; nowhere near as large as they were a decade ago, but big enough for a collapse in share prices to hurt. These shareholdings have become the banks’ toxic waste that has shrunk their capital bases and made it tougher for them to lend.

What Are The Authorities Doing?
Policy response in Japan makes the Europeans look like beavers on steroids. If any country has experience to learn from, it was Japan, exponents of the original non-working model in re-inflating the economy.

Unfortunately the country is saddled with an impotent government, unable to force through stimulus measures and too unpopular with the electorate to consider an early election.

Interest rate policy is a non-starter as Japan has the original ZIRP (Zero Interest Rate Policy); rates are at 0.1%.

Both the government and the Bank of Japan have announced plans to buy shares from the banks if they choose to sell. The thing is, with the index close to its 26-year low the banks probably aren’t too keen on dumping their shares now and realising their losses.

There’s also a programme to buy up commercial paper and corporate bonds, but again there are concerns that this won’t help the companies in desperate need of borrowing.

Previous experience during the 1990s has shown a healthy cynicism amongst Japanese investors who, rather than gaining confidence from government initiatives, use any resulting rally in share prices to offload their holdings. They also tended to use any ‘give-aways’ to increase their savings.

Where Next For The Yen?
All of the above have left the Yen in a pretty sickly state. But was this an obvious and necessary correction after last year’s move or is this the start of a long-term reversal?

Certainly traders will be looking for USD/JPY to hit 100 in the near future; after that there’s less certainty except to predict a range of 112-115 by year-end. For me, as a trader, that’s too far to care about (or believe).

The thing is, after such a strong move, the market might just want to settle back and take stock. Folk lore has it that Japanese investors repatriate funds ahead of their fiscal year-end in March. So that could be a good excuse for a bit of short-term profit-taking. Having said that, last week saw Y1,721 billion leave the country for overseas investments.

An imminent change to lift corporate tax on the repatriation of overseas earnings could happen in the next few weeks. This could see a flood of money return home in April to boost low cash balances.

How Am I Looking To Play This?

Sterling Yen meets resistance at Y142

The chart’s looking good; the 21-day moving average has crossed up through the 50-day moving average. The RSI and MACD are supportive and the ADX has just confirmed a ‘weak trend’. With an 8 pip dealing spread, and testicle-shrivelling volatility, this will be a small bet size with a wider than usual stop loss. But first I want to see the 100-day moving average and January’s high cleared, otherwise this could end up being no more than the top of a large and expensive trading range.

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