Puts on the Yen - Not Too Late as Bank of Japan Attempts the Impossible Trinity

Research & Analysis Swing Trades
1

@juangomez053 (Scalpy_Boi) first brought this up on trading floor but it’s been a very profitable trade with some room to still take advantage of. The House and The_Ni have also provided valuable input on this in the Stagflation thread but I thought it might deserve it’s own as it doesn’t necessarily have to do with US economic growth. I don’t trade FX but have been doing it indirectly through ETFs that short the Yen.

Also, I don’t know shit compared to Juan, House, and Ni. If you need a better explanation then the mess I’m gonna type just scroll to the bottom for the Bloomberg article. For those that want a deeper dig to the economic theory of why the Bank of Japan is attempting the impossible, there’s an Investopedia article (I half understood).

https://twitter.com/biancoresearch/status/1516429170229886977?s=21&t=HnIGMzSOPz-O34MOcd64Yg

Unfortunately, life is getting busier for me and looks to be getting busier in the near future. Unfortunate, because I’ve been learning so much from Valhalla and I’ve started to find my groove - especially through Conqueror’s Challenge (love you, Conq!). But I am going to try and be more active on the forums and also try for more slow-moving swing trades. The caveat being in this volatile market, I still have to be diligent in monitoring my positions and not get stopped out.

The Set-Up

  1. Japan is the biggest purchaser of US 10-Yr Treasuries, even more than China.
  2. The Yen has been depreciating against the Dollar, today hitting 10-yr lows as it broke over 130Y to 1USD.
  3. The Bank of Japan (BoJ) has committed to control the yield curve of Japanese Government Bonds (JGBs) stating that they will purchase unlimited amounts of JGBs to keep rates low (think the Fed’s recent QE and purchasing of treasuries) to stimulate their economy.
  4. This has created a large spread between JGBs and US treasuries.

The Context
Confusing? Maybe I’m just doing a shitty job explaining. The big takeaway is that BoJ has committed to keeping its interest rates low by trying to buy it’s own JGBs but it’s creating major depreciation of the Yen.

So what? Well most countries communicate and have agreements in place with respect to monetary policy. They’re vague, tacit agreement that say shit like “look towards stability of currency markets”. But it helps to let other countries know what you’re thinking, especially if they’re so closely tied like Japan is to the US, or how Japan is to it’s Asian neighbours.

This is a big deal because right now Japan is going it alone. Think about the entire world right now, who the hell is cutting interest rates or attempting to keep them low? This easy money is having a small bump in the Japanese economy but they also import many resources (like energy) and costs aren’t being passed on to the average person through higher prices - yet.

Japan hopes that easy money will stimulate domestic demand, a weaker Yen will make their exports cheaper, and this will create growth. Oh, also, they have elections this August so politically you don’t want the economy to shit the bed before you go and ask for votes.

Something has to give. Either the US helps out the BoJ (not likely) or the BoJ abandons it’s easy money policy (not in the near future).

The Trade

Some say this trade is done:

  • The Yen has depreciated 10% against the USD in a month
  • The days of looking at the Yen as a safe-haven for investors might be over too, as they take a closer look at the Japanese economy and see cracks
  • Japan is also the world’s 2nd largest creditor, meaning they sit on a ton of foreign currency reserves, and could just start selling their piles of USD to bring the Yen back up

But there is still room here, albeit a narrow one. The belief is that the Yen has to depreciate to around 135-140 Yen to 1 USD, for “maximum pain”, before the BoJ would intervene and prop up the Yen. I think we can get there because:

  1. BoJ is committed to keeping rates low, and continually buying up JGBs, at least in the near future (several months, maybe until the end of year). Politically, even more pressure to do this.
  2. As more investors keep sniffing at the Japanese economy they’re gonna realize it’s really dogshit sprayed with perfume, and that will cause selling pressure on the Yen.
  3. More importantly, the USD is the most politically stable and strongest asset anyone can own anywhere in the world. So in direct relation to the USD, the Yen has much more room to go down. Namely, the 130-135 range.

$YCS is the leveraged Short-Yen ETF. In the near term, if FOMC next week raises rates to 50bps, we should expect to see a bump up in 10-Yr Yields creating more pressure on the Yen to depreciate.

Should the Yen start to fall to 103-104** (edited to be more conservative), $YCS 05/20 10c will be ITM.

https://www.bloomberg.com/news/articles/2022-04-28/yen-s-historic-fall-signals-rewrite-of-global-currency-playbook

https://www.investopedia.com/terms/t/trilemma.asp#:~:text=Trilemma%20often%20is%20synonymous%20with,its%20international%20monetary%20policy%20agreements.

5 Likes
2

Thanks Macro for taking the time to write this out!!! Going to post some links I could find about BoJ from TF onto here:

https://twitter.com/DeItaone/status/1517518922446262272

https://twitter.com/charliebilello/status/1519686245135355905?s=21&t=D-tvAJY9WrDU38FgRAonCw

https://twitter.com/DeItaone/status/1508362775273345024

https://twitter.com/financialjuice1/status/1516586065875898376?s=21&t=LP978dL3Wh9g0iCEpmBgcw

Also make sure to read the discussion we had on the Stagflation thread starting here:

3

As always, Juan is earlier than most! The Yen looking like it’s retracing a bit. More on that below.

Here’s some interesting articles:

The Retracement

More importantly, I should have looked into the technicals of $YCS and the Yen on this run up. The crude orange arrows are the jumps up in $YCS (daily candles) followed by about 4-5 days of retracement where it breaks below the orange breakouts before climbing back up.

Yesterday was the breakout up and today we saw the pullback. If the last 2 retracement patterns hold, it could break below $103 in the next 3-4 days before breaking to the upside.

image
image1879×903 116 KB

If we want to just look at the Yen to USD, it’s trading in an upward channel right now:

image
image1873×904 126 KB

Again, the major risk here is that the Dollar has peaked against the Yen but with more bearish sentiment in worldwide markets, the USD is going to be looked at as a safe haven. It should appreciate organically against the Yen. When you factor in the money printing the BoJ is doing it should be enough of an accelerant for this trade to still catch some flames.

Have a great weekend, all!

2 Likes
4

Japanese consumer confidence gained for the first time in 6 months as COVID-related lockdowns came to an end. Still, most consumers feel that inflation is a concern and expect food and energy prices to rise within the next few months. It’s pretty much a nothingburger as the economic data isn’t a stern warning to the BoJ to tame inflation but also not a condemnation of their policies to lead to political risk.

More importantly, with the ECB and Europe showing signs of weakness, the US Greenback continues to show relative strength against other world currencies. This week’s rate hike should provide more fuel to the flame.

<https://money.usnews.com/investing/news/articles/2022-05-02/japan-april-consumer-confidence-improves-for-first-time-in-six-months-government?

1 Like
5

This article describes what @TheMadBeaker posted on TF yesterday on how Japanese institutional investors (pension funds, life insurers) have slowly started to divest about $60B in US Treasuries. They are usually a major buyer of these bonds.

As @The_Ni pointed out, these moves are usually hedged against currency fluctuations but because of the depreciation in the Yen, the cost to hedge has eaten into any yield gains. This article suggests that Euro bonds would be more favourable as the dollar continues to surge.

There’s still debate as to whether a depreciating Yen is good for the Japanese economy. It’s certainly good for Japanese conglomerates as they have many of their manufacturing sites offshore and then the revenue collected translates to more Yen at home. For domestic industries, it makes exports cheaper, but those that rely on foreign inputs are having their costs increase significantly.

For the average Japanese consumer, it sucks. Cost of living inflation has started to inevitably trickle down in higher food and energy costs. Unfortunately, wages have remained flat. This is the political game of Russian roulette the BoJ is playing as they’re hoping to see the benefits of weaker Yen soon before pissing off the Japanese consumer too much in time for August elections.

The bottom line is that most believe even with BoJ intervention, it would do little to prop up the value of the Yen in the short-term and there is still some room for the Yen to depreciate against the USD. FOMC and QT are going to be significant catalysts to start the depreciation of the Yen. Also note that Japan is on holidays until Friday.

https://www.bloomberg.com/news/articles/2022-05-02/japan-seen-unlikely-to-intervene-with-fed-s-jumbo-hike-looming

3 Likes
6

This play still exists. Retracement seems to be complete, but as mentioned, Japan’s markets will be open on Friday.

Think the best entries for YCS calls will either be before tomorrow or near EOD Thursday.

1 Like
7

Thanks so much to Tiddly for taking a look a the TA for this trade. After a major selloff of the USD yesterday, seems like investors came to their senses and realized the 50bps increases for the next few months is still a significant measure. Once this starts to trickle more into the bond market, and with the BoJ expected to keep rates unchanged until August elections (and even further) the spread between rates is now solidified.

The Yen looks to have almost completed it’s retracement and is still trading in that upward trending channel of the bollinger bands. We’re going to want to see continued green candles from here on in until the next breakout candle.

image
image1890×903 134 KB

We may get some political posturing from G7 and G20 leaders as to FX markets but it’s not the main concern for world leaders as this article states:

1 Like
8

Just an update after close:

USD rallied hard against the Yen and other currencies reaching a peak today before cooling off. The 10-Yr Yield crept above 3.1% and is over 3% AH. Saw the green candle we needed to and should expect to see a lot more as there are some catalysts at play over the weekend:

  1. Japanese markets open up today after a 3-day holiday and usually jumps up in USD/Yen happen overnight.

  2. Lots of Japanese economic data released Sunday night (Japanese Monday morning) but the key will be BoJ Meeting Minutes where we should expect them to keep yield curve controls but also gripe about Yen depreciation.

    image
    image1219×403 53.6 KB

Most now expect the Yen to depreciate up to 135 (BoA analysts) as its currently at 130. Couple of articles suggest that the BoJ would intervene when the Yen tops off at 140 as it’s been a historic level for weakness in the domestic Japanese economy. Should that happen, analysts believe Japan could possibly prop the Yen by spending up to $100B in FX reserves. All’s to say is there’s still room for this trade to print.

Some believe that we’re near bottom for the Yen and that it could be seen as a safe-haven again if the world continues to go to shits.

1 Like
9

Update on the trade

This trade continues to develop at a nice slow pace. Today, the Yen closed above 130.50 as the 10-Yr Yield broke above 3.1%. If the BoJ continues its dovish stance on Sunday according to it’s minutes, I’m hoping we see a break above the 130.85 by Monday or Tuesday as this would keep the upward trend in the channel. The interest rate squeeze is on!

Macro News

Inflationary news out of Japan suggests April reached above 2%. More importantly, analysts and economists believe inflation would need to rise to above 3% before it started to have a dampening effect on domestic demand. At 3% inflation, it aligns with the target of the Yen depreciating to 140 in order for the BoJ to intervene or for them to reverse course and raise rates.
https://www.businesstimes.com.sg/government-economy/economists-see-japans-inflation-hitting-at-least-21-in-april

Educational Reading

Here’s an interesting article on the “Carry Trade” and it’s dynamics. The_Ni mentioned it once but I was too stupid to understand it. Basically, short-term interest rate arbitrage but can implode without proper currency hedging.

Long USD, Short Yen

Also, it appears that traders are betting on the US dollar (and shorting the Yen) as of this week.

image
image1190×511 35.4 KB

Headwinds

One concern is that CPI numbers come in below forecast or Core inflation looks to have peaked. That could indicate that peak inflation has passed and that the Fed may not have to be as hawkish with future policy decisions. I think that reaction would be short-lived at least for a couple of months. China’s lockdown continues to be a major cause of inflation due to supply-chain delays and we haven’t seen the reduction in energy costs to offset.

Hope all the moms have a great Mother’s Day Weekend!

1 Like
10

This is a great update, Macro!! The more data we get, the more the same message becomes clearer and clearer:
“ However, as the BOJ tries to stop rates from rising, they weaken the yen. Japan is in a trap . They can protect interest rates or the yen but not both .”
Great stuff!!!

11

JPY hitting 130.72, BOJ minutes from March meeting came out today:

Highlights:

WE WILL NOT HESITATE TO ADD EASING IF NECESSARY.

MEMBERS AGREED THAT INCREASED FOREIGN DEMAND AND ACCOMMODATIVE MONETARY POLICY WILL HELP JAPAN’S ECONOMY RECOVER.

MARKETS MAY BECOME RISK-AVERSE IF RISING INFLATION PROMPTS CENTRAL BANKS TO WITHDRAW MONETARY EASING.

IF CHINA’S LOCKDOWN MEASURES DISRUPT FIRMS’ LOCAL PRODUCTION, THEY COULD HAVE A SIGNIFICANT NEGATIVE IMPACT ON JAPANESE EXPORTS.

THE BOJ MUST HELP THE ECONOMY RECOVER FROM THE EFFECTS OF THE PANDEMIC BECAUSE JAPAN IS NOT IN A POSITION WHERE INFLATION CAN SUSTAINABLY EXCEED ITS 2% TARGET.

THERE IS NO NEED TO INCREASE STIMULUS BECAUSE THE ECONOMY IS EXPECTED TO CONTINUE TO RECOVER.

THE BOJ MUST CONDUCT MARKET OPERATIONS TO KEEP LONG-TERM INTEREST RATES FROM RISING.

MEMBERS AGREED THAT SHORT- AND LONG-TERM POLICY RATES WILL REMAIN AT CURRENT OR LOWER LEVELS.

INFLATION IN JAPAN MAY EXCEED 2% IN THE SHORT TERM.

Good article summarizing/explaining situation of USD/JPY:

https://www.barrons.com/articles/japanese-yen-value-51651847360

12

You’re the best, Juan! Thanks so much for the March minutes update!

Just wanted to add this article also references some guidance from their April meeting and it’s just more of the same QE talk (I think they release pressers weeks before the minutes of each meeting):

Data released on Monday showed real wages shrank in March for the first time in three months, a sign salaries weren’t rising enough to make up for higher living costs.

The BOJ maintained its massive stimulus at the March 17 to March 18 meeting. At a subsequent meeting in April, it raised this year’s inflation forecast, but stuck to ultra-low interest rates and guidance to sustain easy policy.

Many analysts expect Japan’s core consumer inflation to exceed 2% from April onward mainly on rising fuel costs. The BOJ has said it won’t tighten policy unless such cost-push inflation leads to broader price rises accompanied by higher wages.
https://www.japantimes.co.jp/news/2022/05/09/business/boj-policymakers-unwavering-monetary-stance/

Just some added notes I’d like to add for today:

  • It’s not critical since the BoJ is going to practice QE to maintain their yield curve at 2.5% but might be good to keep an eye on JGB (Japanese Government Bond) 10-Year Yields if it dips significantly below that 2.5% target? Could signal a sign that markets might be getting confident in the Yen again.
    https://www.marketwatch.com/investing/bond/tmbmkjp-10y?countrycode=bx

  • The Yen hit a premarket high of 131.335! I’ve noticed It usually has a dip/sell-off around 8:00-8:30 before climbing back up. Don’t know if this is just the way currency markets regularly move but it usually finds a middle ground somewhere between PM high and 8:00 dip.

  • Waiting out CPI numbers but I think the Yen is screwed either way. If they come in same/higher, inflation sentiment will be that inflation is here to stay and the subsequent increase in the 10-Yr yields, exasperating the spread. If the CPI numbers come in cool, and inflation looks like it’s peaked, the USD becomes even more of a safe-haven in these volatile markets as it looks positive for economic growth/recovery.

1 Like
13

Today was an interesting day as yields began to drop in treasuries but also corresponded with a drop in SPY. As always, The_Ni does a great job of presenting the thesis as to why: Bonds r screwed - #22 by The_Ni?

In short, bonds could be back in fashion as investors are pulling their money out of equities for the stability of treasuries and guaranteed returns. Frankly, I didn’t expect such a strong move into bonds but like every change, there should be an adjustment period before the markets digest the strength of the USD and the relative weakness of the Yen. Yields can only go down so much as the Fed is going to announce interest rate increases for the next two months regardless of the economic data. Also, it’s all relative and the USD should still appreciation to other struggling economies’ currencies:

image
image835×496 31.9 KB

Here’s the calendar for Japan economic data release. At 1:35AM tomorrow, the 10-Year JGB Auction is going to be held and should gives us an idea about the appetite for JGBs.

image
image1025×864 104 KB

1 Like
14

Worth a read:

15

https://twitter.com/Financialjuice1/status/1523841148355489792?s=20&t=11z4i_nnkF-sxoV19Z-AWw

https://twitter.com/Financialjuice1/status/1523840419087409153?s=20&t=11z4i_nnkF-sxoV19Z-AWw

https://twitter.com/Financialjuice1/status/1523838949017497601?s=20&t=11z4i_nnkF-sxoV19Z-AWw

https://twitter.com/Financialjuice1/status/1523835519901356034?s=20&t=11z4i_nnkF-sxoV19Z-AWw

https://twitter.com/Financialjuice1/status/1523826737922117632?s=20&t=11z4i_nnkF-sxoV19Z-AWw

https://twitter.com/Financialjuice1/status/1523827100775497728?s=20&t=11z4i_nnkF-sxoV19Z-AWw

https://twitter.com/Financialjuice1/status/1523827567828123648?s=20&t=11z4i_nnkF-sxoV19Z-AWw

Speeches happening in Japan right now.

1 Like
16

https://twitter.com/charliebilello/status/1523847336635600897?s=21&t=GmQmmaJR_9O35sVhbFfQNQ

1 Like
17

Thanks for the resource article, Juan! Really laid out clearly how the relationship between USD and JPY isn’t just a currency pair but contingent on US treasuries. Just some notes for today:

  • BoJ did their 10-Yr JGB auction at a 0.245% yield. But right now it looks like it’s trading higher than the 0.25% target so should expect more QE from the BoJ. As Juan’s pointed out, the new statement out from the BoJ is that they won’t be increasing the “band” for the yield on the JGB to 0.35 as some suggested to control depreciation of the Yen.

    image
    image958×838 43.5 KB

  • However the US 10-Yr keeps seeing a lot of buying pressure as yields continue to drop. In PM, it’s currently at 2.965%, down almost 3.57% from yesterday’s close. If Treasuries are the safe haven that investors are turning to, we could see a break in the upward trend that the USD/JPY pairing has been doing so nicely.

  • This could also all be in anticipation of CPI numbers to be released tomorrow.

18

Update on the Trade
Today was definitely a break in trend. Both the Yen appreciation and the 10-Yr Yield drop, which unsurprisingly move pretty much 1-1 in this upswing, have broke from their usual pattern. I think it’s time to reposition (or even reconsider this trade) for a variety of reasons:

  1. Although the US$ has surged in price compared to other currencies, the Yen has found even more favour (relatively) in a short time and is looking like a safe-haven asset again. There are quite a few sources that believe the Yen will appreciate from here on in.

  2. The 10-Yr Yield continues to drop. Whether this is the shift to treasuries that investors are seeking (capitulation to a bear market) it seems there is a lot of buying pressure. The 10-Yr Yield was at 0.3167% just 4 days ago and has since dropped to 0.2843%. That’s a drop of 10.73%

  3. There aren’t that many catalysts until next month. That is when QT begins for the Fed and when that liquidity is removed from the market, we should see appreciation in the dollar. More importantly this should put increased upward pressure on rates along with the expect 50bps increase.

To show you just how much the 10-Year Yield and Yen trade in tandem since March, subsequent increases match appreciation in the US$:

image
image1890×900 105 KB

image
image1893×914 133 KB

Besides breaking the trend, someone that’s better at TA than me stated that a break below 128.60, which would be the last level of support since the breakout on 4/28. Today’s break below signals more of a downward turn.

Outlook
All the projections are that the 10-Yr will trade within the range of 0.290-0.32% till the end of 2022. Japanese stocks continue to be unimpressive and domestic Japanese demand is not rising. The BoJ will have more incentive to keep yields low.

I’m gonna take a longer view here as next month brings more catalysts. My inclination is that China’s COVID lockdowns could start to loosen in June and should see the Yuan start to show some strength and take away from the Yen’s recent strength.

1 Like
19

That’s a lot of net selling of US Treasuries by foreign entities in March 2022. About $100B in total, globally, with Japan $70B of it.

Couple of interesting things here.

One line of thought was that the much higher yields would bring in foreign investors. And we see that - UK with +9B, Cayman Islands with +18B, France with +8B etc.

However, those flows are overwhelmed when a whale like Japan belches. With China helping with another $15B in selling.

Note that this is a lot more than the $17.5B->$35B QT that the Fed has announced. Not sure how much the Fed was counting on this additional source of QT.

image
image454×797 21.4 KB

2 Likes
20

Fascinating to watch this play out in such a condensed time period. Seems as though it’s not just US Treasuries that Japanese investors are deciding to pass on although so small in comparison to Treasuries:

image
image963×747 63 KB

I don’t see how the rate hike in June and the begging of QT is going to add liquidity to the market. Going to be watching the interest climb like a Broadway show!

Some key economic indicators coming out of Japan this week starting with GDP numbers tomorrow and CPI numbers on Thursday.

1 Like