What has the Yen flash rally of 2019 taught us?

Yesterday we took a look at the low-level of bond yields for this stage in the cycle and the US Treasury Note yield has fallen further since to 2.63%. Also I note that the 0.17% ten-year German bond yield is being described as being in interest-rate cut territory for Mario Draghi and the ECB. That raises a wry smile after all the media analysis of a rise. But it is a sign of something not being quite right in the financial system and it was joined last night by something else. It started relatively simply as people used “Holla Dolla” to describe US Dollar strength ( the opposite of how we entered 2018 if you recall) and I replied that there also seemed to be a “yen for Yen” too. So much so that I got ahead of the game.

What I was reflecting on at this point was the way that the Yen had strengthened since mid December from just under 114 to the US Dollar to the levels referred to in the tweet. For newer readers that matters on two counts. Firstly Japanese economic policy called Abenomics is geared towards driving the value of the Yen lower and an enormous amount of effort has been put into this, so a rally is domestically awkward. In a wider sweep it is also a sign of people looking for a safe haven – or more realistically foreign exchange traders front-running any perceived need for Mrs.Watanabe to repatriate her enormous investments/savings abroad  –  and usually accompanies falling equity markets.

The Flash Rally

I was much more on the ball than I realised as late last night this happened. From Reuters.

The Japanese yen soared in early Asian trading on Thursday as the break of key technical levels triggered massive stop-loss sales of the U.S. and Australian dollars in very thin markets. The dollar collapsed to as low as 105.25 yen on Reuters dealing JPY=D3, a drop of 3.2 percent from the opening 108.76 and the lowest reading since March 2018. It was last trading around 107.50 yen………..With risk aversion high, the safe-haven yen was propelled through major technical levels and triggered massive stop-loss flows from investors who have been short of the yen for months.

As you can see there was quite a surge in the Yen, or if you prefer a flash rally. If a big trade was happening which I will discuss later it was a clear case of bad timing as markets are thin at that time of day especially when Japan is in the middle of several bank holidays. But as it is in so many respects a control freak where was the Bank of Japan? I have reported many times on what it and the Japanese Ministry of Finance call “bold action” in this area but they appeared to be asleep at the wheel in this instance. Such a move was a clear case for the use of foreign exchange reserves due to the size and speed of the move,

There were also large moves against other currencies.

The Australian dollar tumbled to as low as 72.26 yen AUDJPY=D3 on Reuters dealing, a level not seen since late 2011, having started around 75.21. It was last changing hands at 73.72 yen.

The Aussie in turn sank against the U.S. dollar to as far as $0.6715 AUD=D3, the lowest since March 2009, having started around $0.6984. It was last trading at $0.6888.

Other currencies smashed against the yen included the euro, sterling and the Turkish lira.

There had been pressure on the Aussie Dollar and it broke lower against various currencies and we can bring in two routes to the likely cause. Yesterday we noted the latest manufacturing survey from China signalling more slowing and hence less demand for Australian resources which was followed by this. From CNBC.

 Apple lowered its Q1 guidance in a letter to investors from CEO Tim Cook Wednesday.

Apple stock was halted in after-hours trading just prior to the announcement, and shares were down about 7 percent when trading resumed 20 minutes later.

This particular letter from America was not as welcome as the message Tim Cook sent only a day before.

Wishing you a New Year full of moments that enrich your life and lift up those around you. “What counts is not the mere fact that we have lived. It is what difference we have made to the lives of others that will determine the significance of the life we lead.” — Nelson Mandela

So the economic slow down took a bite out of the Apple and eyes turned to resources demand and if the following is true we have another problem for the Bank of Japan.

“One theory is that may be Japanese retail FX players are forcing out of AUDJPY which is creating a liquidity vacuum,” he added. “This is a market dislocation rather than a fundamental event.”

Sorry but it is a fundamental event as Japanese retail investors are in Australian investments because they can get at least some yield after years and indeed decades on no yield in Japan. This is a direct consequence of Bank of Japan policy as was the move in the Turkish Lira which is explained by Yoshiko Matsuzaki.

This China news hit the EM ccys including Turkish lira where Mrs Watanabe are heavily long against Yen. I bet their stops were triggered in the thin market. Imagine to have TRYyen stops in this market.

So there you have it a development we have seen before or a reversal of a carry trade leading the Japanese Yen to soar. Even worse one caused by the policy response to the last carry trade blow-up! Or fixing this particular hole was delegated to the Beatles.

And it really doesn’t matter if I’m wrong
I’m right

Bank of England

It too had a poor night as whilst it is not a carry trade currency with Bank Rate a mere 0.75% the UK Pound £ took quite a knock against the Yen to around 132. Having done this we might reasonably wonder under what grounds the Bank of England would use the currency reserves it has gone to so much trouble to boost? From December 11th.

Actually the Bank of England has been building up its foreign exchange reserves in the credit crunch era and as of the end of October they amounted to US $115.8 billion as opposed as opposed to dips towards US $35 billion in 2009. So as the UK Pound £ has fallen we see that our own central bank has been on the other side of the ledger with a particular acceleration in 2015. I will leave readers to their own thoughts as to whether that has been sensible management or has weighed on the UK Pound £ or of course both?!

To my mind last nights move was certainly an undue fluctuation.

The EEA was established in 1932 to provide a fund which could be used for “checking undue fluctuations in the exchange value of sterling”.

It is an off world where extraordinary purchases of government bonds ( £435 billion) are accompanied by an apparent terror of foreign exchange intervention.

Comment

I have gone through this in detail because these sort of short-term explosive moves have a habit of being described as something to brush off when often they signal something significant. So let is go through some lessons.

  1. A consequence of negative interest-rates is that the Japanese investors have undertaken their own carry trade.
  2. The financial system is creaking partly because of point 1 and the ongoing economic slow down is not helping.
  3. Contrary to some reports the Euro was relatively stable and something of a safe haven as it behaved to some extent like a German currency might have. There is a lesson for economic theory about negative interest-rates especially when driven by a strong currency. Poor old economics 101 never seems to catch a break.
  4. All the “improvements” to the financial system seem if anything to have made things worse rather than better.
  5. Fast moves seem to send central banks into a panic meaning that they do not apply their own rules.

We cannot rule out that this was deliberate and please note the Yen low versus the US Dollar was 104.9 as you read the tweet below.

Japanese exporters had bought a lot of usd/jpy puts at year end with 105 KOs so now they are really screwed … ( @fxmacro )

Me on The Investing Channel

 

 

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Monetary policy seems to have been delegated to the currency markets

Last night was simply superb at what might be called the battle of Stamford Bridge where at times an exciting football match broke out leading to a 2-2 scoreline which meant that previously lowly Leicester City are champions of the premier league. Well done to them and their fans and it was a shame that the sonic booms of the RAF Typhoons in the air were over another town beginning with a L namely Leeds. It makes me think how bad we are as humans at comparing events with perceived ultra low probability. From Hilary Evans.

Betting odds in August. Leicester to win Premier League 5000-1 Elvis to be found alive working in a chip shop in Macclesfield 2000-1

Oh and the 2000-1 bet was probably influenced by fans of this song from Kirsty MacColl.

There’s a guy works down the chip shop swears he’s elvis

However there is another event or two be precise two events taking place now that according to economic theory should not be happening and we find them in the currency markets.

The currency depreciators in fact appreciate

There has been a change in 2016 and what it represents is that the two main central banks which are trying to lower their currency have in fact seem them rally. This morning there were two clear notable sights in markets as the Euro pushed towards 1.16 versus the US Dollar and the Japanese Yen strengthened though 106 to 105.6. This will have Mario Draghi of the ECB spluttering on his morning espresso or cappuccino and perhaps ordering an extra glass of chianti with his lunch. Actually as Mario notes that around a third of the new bank rescue fund for Italy has already been used he may raise his chianti order to the whole bottle!

Meanwhile in Japan Governor Kuroda will not be in a mood to celebrate the 3 day Golden Week break and of course if anyone has had an anti-Midas touch it is him. As in essence the policy of Abenomics he was appointed to enforce involved a lower Yen there is an obvious problem with it rising. In fact even hard-core supporters must be struggling to name an arrow of Abenomics that is even partially working right now and I wait to see how the many in the media deal with this reality.

Let us analyse the scale of what has taken place here. It reminds me of quite a few instances in UK economic policy where the UK Pound £ has done exactly the reverse of both plans and hopes for it.

The Euro

As a backdrop we need to recall that the ECB has cut its deposit and current account interest-rate to -0.4% and raised its monthly amount of QE (Quantitative Easing) bond purchases to 80 billion Euros a month, or just shy of a trillion a year. What has it got for that?

If we look at the chart against the US Dollar we see that the falls were in 2014 and early 2015 and that over the past year the Euro is now up by over 3%. This fits with my theory that the main currency falls from a policy of QE happen in advance of it as expectations build and that the reality of it sees a situation where the boat often has already sailed. If we look at the effective or trade weighted exchange rate it fell from 104 to 89 in early April 2015 but has since rallied to 95.

A couple of years ago we did get a “Draghi Rule” for measuring the impact of all this.

Now, as a rule of thumb, each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points.

So the same inflation which he is trying to raise will in fact be reduced by around 0.3% by the Euro strength.

Oh and the ECB is also pot-shotting at the behaviour of other central banks. Whilst I welcome that it is catching up a little with my “early-wire” theme it seems to have forgotten that it used to give private-briefings to hedge funds.

Eleven out of these 21 announcements exhibit some pre-announcement price drift in the “correct” direction, i.e., in the direction of the price change consistent with the announcement surprise. For seven of these announcements the drift is substantial.

 

The Yen

Whilst the Yen has been something of a currency twin with the Euro it has been in the worst place as you see it has rallied against it as well. Cue more pictures of Governor Kuroda with his face in his hands. Back in late 2014 it just failed to make 150 Yen per Euro compared to the 122.5 now. Thus the Yen has surged and with apologies for it being tardy with updates but the trade weighted Yen courtesy of the Bank of England has risen from 127 to 141 over the past year.

Sadly the Bank of Japan has not published any form of the Draghi Rule as I suppose it is anti their culture. But of the rules we do have I think it applies the most so we see that inflation will be some 0.6% lower due to the appreciation over the past year. The calculation assumes we remain here as do the ones above and they give plenty of food for thought.

Another way of looking at the situation is that Abenomics has jumped into the TARDIS of Doctor Who and travelled back to November 2013.

The UK

There has been a reversal here too as the falls of early 2016 have been followed by a recovery to US $1.47. The trade weighted index has recouped about half of its earlier losses with in essence the 2016 falls being against the two currencies discussed above. Of course so much is in flux but with UK manufacturing weak and the Pound stronger we could easily see someone at the Bank of England vote for a Bank Rate cut. At which point we see yet another reversal for Forward Guidance.

Australia

If we look to the land “down under” we see that the Reserve Bank of Australia cut interest-rates by 0.25% to 1.75% this morning. This did seem to be aimed at one particular target.

though an appreciating exchange rate could complicate this.

As the “Aussie” has fallen I guess they will be happy. Those familiar with the UK experience will feel a chill down their spines as the note the use of “rebalancing” in a situation proving central banks all borrow from each other.

The US Dollar

Here we get the most awkward situation for economic theory as it is raising interest-rates and therefore should have a strong dollar. Reality by contrast fits much more nicely with my anticipation and expectation theme especially as the Federal Reserve seems to have forgotten and redacted its own Forward Guidance. The Dollar Index had a couple of goes at passing 100 but now is at 92. According to US Federal Reserve vice-Chair Fischer that will raise GDP by between 0.8% and 1.2%

So we have the country which was tightening monetary policy via interest-rate rises ( although in reality we do not need the plural as only one has happened so far) and a higher currency is now seeing easing via currency falls. Oh what a tangled web and all that..

Comment

I have left one elephant in the room until now which is the supposed existence of a Shanghai Accord. Some elements of it do seem to be in play but I am cautious about conspiracy theories especially in currency markets. Maybe that is because I am British as the UK Pound £ has spent so much time at the “wrong” level meaning that we have not been able to control it! Maybe just the existence of the theory has contributed to what we have seen especially as we note that the moves were already in play well before the accord.

But as the moment most currencies seem to be getting what their central banks do not want! Still according to the Rolling Stones that may not be all bad.

You can’t always get what you want
But if you try sometime you find
You get what you need