Has The Yen Died?

Don't Call the Undertakers Just Yet …

It has become quiet around the yen – too quiet, Kemosabe, as Tonto would say. No-one talks about the yen anymore, because by all indications, it has passed away. If it hasn't kicked the bucket, then it is at least definitely not moving anymore. However, we suspect it is just sleeping. Consider the daily chart of  cash yen below. While its daily movements have become smaller and smaller, especially compared to the wild moves seen in 2012-2013, it has quietly built a rising triangle (resp. a falling triangle in the usual yen-dollar notation). A triangle always means that a large, volatile move lies dead ahead. The direction is not 100% certain of course, but rising triangles have a very high probability of resolving in an upside breakout. That would certainly surprise a great many people, including Japanese policymakers.

Since the beginning of the year, a rising triangle has formed in the yen. Or let us rather say, it has been sneaking up on everyone, putting traders the world over to sleep. Our guess is that it and they will wake up very soon. In this notation the yen becomes stronger when prices move up (normally the notation is shown the other way around) – click to enlarge.

Speculators have reduced their short positions in the yen as the triangle was formed,  but remain net short by almost 100,000 contracts, which indicates that  bearish sentiment on the currency remains quite pronounced. In other words, we are looking at a “dull market” with a large short position. This argues for a fairly imminent strengthening of the yen as well.

Commitments of traders in yen futures – not as extreme as they once were, but speculators still remain short by nearly 100,000 contracts net – click to enlarge.

Why is this important? The yen usually rises when risk assets decline, as Japanese investors tend to repatriate capital and carry trades tend to be covered whenever that happens. Hence the technical and sentiment situation in the yen can be seen as an early warning indicator for stock and junk bond markets.

It's too quiet Kemosabe … Tonto discusses the yen with the lone ranger.

(Photo credit: Peter Mountain)

Industrial Suction

Japan just reported that industrial production has slightly increased last month. The increase came in below expectations, but was large enough to rekindle talk of a BoJ “exit” from quantitative easing – at the very least it seems that it means that the BoJ's 'QE' operations won't be expanded further for the time being:

“Japan's factory output rose in May after companies cut production in April to offset the impact of a national sales tax hike, underscoring views the economy will absorb the increase largely unscathed.

The 0.5 percent month-on-month rise compared with the median estimate of a 0.9 percent increase in a Reuters poll of economists, and followed a 2.8 percent drop in April, data from the Ministry of Economy, Trade and Industry showed On Monday.

The data is likely to support a view that the economy will rebound in the summer from the April 1 sales tax rise and spending slump in the current quarter. That rebound could further dampen expectations the Bank of Japan will ease policy again this year, as it is likely to support the bank's optimistic view of an economy is on track to resume moderate recovery and meet its 2 percent inflation target.

Manufacturers surveyed by the ministry expect output to fall 0.7 percent in June but grow 1.5 percent in July, the data showed on Monday. Market reaction was muted. "Output is recovering. But it is still in the stage of adjustments given falling shipments and rising inventory," said Takeshi Minami, chief economist at Norinchukin Research Institute in Tokyo.

The ministry maintained its assessment of factory output, saying it is in a flat trend. The government raised the national sales tax to 8 percent from 5 percent on April 1 to pay for rising welfare costs, which has chilled private spending. Manufacturers have reduced production after the tax hike to avoid piling up inventories.

Analysts expect the economy to contract in the second quarter due to the tax hike, with a Reuters poll conducted in June projecting a 1.2 percent quarterly drop. However, a bigger-than-expected decline in household spending and a drop in exports in May mean that the contraction could be more pronounced and subsequent rebound may be delayed.

The BOJ has signaled that it sees no immediate need to expand its massive stimulus program deployed in April last year, stressing that the pullback in demand after the tax hike will be temporary.”

So what exactly is it about Japan's industrial production that is so exciting?  Beats us. It has gone precisely nowhere since 1990:

Japan's industrial production is right back to where it was in AD 1990, half an eternity ago (i.e., a quarter of century ago – way too long for the attention span of the modern-day average investor) - click to enlarge.

Japan's economy is evidently in a coma since 1990. However, this has of course little to do with the yen. The yen is mainly characterized by the fact that in spite of the BoJ's recent printing efforts, the supply of yen entering the economy continues to grow at a slower pace than both the US dollar and euro money supply. In terms of relative money supply outstanding, things continue to move in the yen's favor – and as noted above, if risk assets should stumble, the yen is highly likely to once again soar – against widespread expectations.

Conclusion:

The yen is likely not dead. Our bet is that is only sleeping, and very close to waking up.

Charts by: BarCharts, Sentimentrader, St. Louis Fed