What the (Yen) is Going On!

What the (Yen) is Going On!

We know, we know – the digital ink is barely dry from our take on the bond market, then we’re turning our attention to currency markets – but hey, you can’t really have one without the other. After all, what do you think all that currency market movement is about… the difference in what can be earned in each currency (via interest rates) relative to one another. To get right into it – the currency markets have been a little crazy as of late. Like crazy crazy. The USD had one of itsbiggest trends higher in 2014, and vice versa with the Euro.  And while that trend was happening, the Swiss Franc (without warning depegged) itself from Euro. All of that calmed down a bit with the USD selling off about 7% from its March highs, but now we have the Japanese Yen calling for some attention.

Seems our old friend Yen Futures are reaching 20 year lows…

JPY 20 year Yen

(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Finviz

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Or if you’re more of a Forex person and used to looking at it as number of Yen per dollar – then it’s breaking and 18-year resistance line to the upside:

Dollar Yen Kimble Charting(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Kimble Charting

Either way, this isn’t something you see every day, or more technically – every 5000 days.  The Yen has been getting smoked over the past week or so, dropping -3.81% in just the last nine trading days (Past performance is not necessarily indicative of future results). If this was crude, we probably wouldn’t be talking about it, but an almost 4% move in a national currency is sort of a big deal. Not to mention the -37.85% move since the beginning of 2012.

Who cares, besides Japanese investors… how about the retired police officer or state college professor. Because the falling Yen is likely a part of nearly all of the worlds largest pensions and endowments, with their heavy use of Alternative Investments using hedge funds, managed futures, and Global Macro strategies.

First up, systematic trend following types who are all about this trade (see long the US Dollar and loving it), even if we don’t understand the socio-economic impact of the BOJ removing theartificial demand for the Yen or postulate on the wisdom of purposely blowing up your currency to try and stimulate economic expansion. All these types of strategies care about is a persistent trend in one direction… say one caused by a governmental policy which results in a weakened currency.

And next up the hedge funds who use the so called ‘carry trade’. Here’s the FT on how that works in the Yen:

Here is how the “yen carry trade,” a favorite currency for the trade, basically works now:

  • Hedge funds and other very big traders borrow the yen at very, very low interest rates now approaching zero.
  • The yen are converted to dollars, which are invested in U.S. Treasuries at a much higher yield than the interest cost for the borrowed yen. That creates a “positive carry” because of the differential in interest rates.
  • The buying drives up U.S. bond prices. The traders accrue big profits, when done with high leverage, assuming the yen value doesn’t rise.
  • Additional profits are made when a) The dollar rises vs. the yen as the BOJ intends, b) U.S. Treasuries rise in price (as is happening)
  • Triple Profits: A leverage 100:1 means that a 1% rise in the value of the dollar vs. yen doubles the value of the equity investment. An additional profit is made if the U.S. T-bonds rise in price as they have done. Further profits are made from the positive carry, i.e. when the yield on the T-bonds is greater than the interest cost on the yen. That’s a “triple profit.”
  • So far, so good. And that’s what is happening now. Some of the profits are probably reinvested in the stock market for diversification.

And what about firms doing both. We covered a while back how managed futures strategies had a devil of a dilemma on whether to add the carry trade to their strategies – perhaps hurting their crisis period performance profile, but helping the rest of the time.

One interesting side note is that the Nikkei 225 Index has been rallying opposite the move in the Yen’s value. Last week, the stock index tracking the Japanese stock market, the Nikkei 225, finally (we repeat) finally surpassed its 26 year old high water mark in terms of market capitalization, via Reuters:

“The total market capitalization of the TSE’s first section rose to 591.30 trillion yen ($4.9 trillion), surpassing the previous peak of 590.09 trillion yen hit in December 1989, when share prices hit record peaks at the height of the Japanese asset bubble.”

Here’s the thing; even though the price of the index remains well below its all-time high – the value of those increased value shares (priced in Yen) may be roughly the same given the decline in the value of the Yen versus the US Dollar.  So while the Nikkei 225 may be up 39.8% over the past 12 months – if we look at it priced in something which is a store of value… say Gold… you see a much different picture:

Nikkei Index in Gold Grams(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Priced in Gold.com

Now, those who trade Yen futures and Nikkei futures via the Chicago Mercantile exchange don’t have this problem, however, with both contracts settled in US dollars (there is a Yen based Nikkei contract, also, if you’re wondering), meaning Managed futures folks don’t quite have the same problem – with the ability to ride any trends that happen, and get out. Although the contracts will have their own performance profile which will represent being priced in US Dollars.

Food Sushi for thought as we watch the Yen careen towards zero. The Yen can’t fall to zero. Can it?


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