Yen In Trouble, Even Before Earthquake

Even before today’s devastatingly tragic earthquake, a confluence of negative factors had begun to pile up behind the Yen. Low interest rates. Low GDP growth. Political infighting. Record national debt. Declining current account surplus. Lack of interest in investing in Japan. In short, while the Yen deserves credit for perseverance, I have to believe that the day of reckoning is near.

On the one hand, Japanese exporters appear to be adapting well to the high Yen, and most of the well-known companies are recording healthy profits. On the other hand, Japan recorded its first trade deficit in two years, and the second largest since 1985. Its current account surplus also fell to a modest $5 Billion, on the basis of high oil prices and declining investment inflows. It seems that both foreign and domestic investors are becoming more wary about Japan, which is being reflected in more capital going out and less coming in. Business Week recently reported that “Investment flows into Japanese mutual funds that focus on offshore assets rose 14 percent to 624.6 billion yen ($7.51 billion) in January from a year earlier.”

In fact, this trend is being driven in part by low interest rates. Japan’s benchmark rate is basically nil, and long-term rates are proportionately minuscule. If not for perennial deflation, real interest rates would probably be the lowest in the world. Given that the Bank of Japan probably won’t raise interest rates for another two years (it’s actually quite ridiculous to even broach the possibility at this point, given that it hasn’t even finished unrolling its monetary easing plan), this phenomenon will only further entrench itself.

It seems that the forex markets are finally taking notice, due in part to last week’s rumblings about ECB rate hikes. As a result, the Japanese Yen is set to resume its role as the funding currency of choice for carry trades. According to a Bloomberg News analysis, in 2011, “Carry trades using the yen gained 23.8 percent [on an annualized basis], compared with 2.8 percent in dollar-funded trades.”That represents an about-face from 2010, when the Dollar was the most profitable funding currency. In addition, volatility is slowly returning to pre-credit crisis levels, increasing the stability (and hence, attractiveness) of the carry trade.

As if that wasn’t enough, the government of Japan continues to run massive budget deficits. Wary of the growing national debt (and perhaps of the recent downgrade of Japan’s sovereign credit rating), the legislature appears unwilling to sanction the issuance of more debt. For better or worse, the resultant political standoff could lead to the ousting of Prime Minister Naoto Kan. If recent history is any indication, it seems unlikely that his successor will break through the political stalemate that seems to plague the country.

It’s hard to find a single analyst that is bullish on the Yen. “The yen may weaken to 86 per dollar by the end of the second quarter and 90 by the end of the year, according a Bloomberg News survey of 40 forecasters.” Meanwhile, speculators are net short the Yen for the first time this year, according to the most recent CFTC Commitment of Traders report. It has already weakened 8% (on a trade-weighted basis) from its 2010 peak, and has depreciated against every single major currency in 2011. Perhaps the strongest indication is that the Bank of Japan has announced that it is no longer preoccupied with the Yen, despite the fact that it is still within striking distance of its all-time high against the Dollar.

In short, while I hesitate to broach the earthquake again for fear of sounding callous, I think it might just provide investors with the excuse they need to send the Yen down, down, down.

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UK Forex Reserve Plan could Harm Pound

Yesterday, UK Chancellor George Osborne announced that his government was ready to begin rebuilding its foreign exchange reserves. Depending on when, how, (or even if) this program is implemented, it could have serious implications for the Pound.

Forex reserve watchers (myself included) were excited by the updated US Treasury report on foreign holdings of US Treasury securities. As the Dollar is the world’s de-facto reserve currency and the US Treasury securities are the asset of choice, the report is basically a rough sketch of both the Dollar’s global popularity and the interventions of foreign Central Banks. Personally, I thought the biggest shocker was not that China’s Treasury holdings are $300 Billion greater than previously believed (with $3 Trillion in reserves, that’s really just a rounding error), but rather that the UK’s holdings declined by 50% in 2010, to a mere $260 Billion.

Given that the Bank of England (BoE) injected more than $500 Billion into the UK money supply in 2010, I suppose that shouldn’t have been much of a revelation. After all, selling US Treasury Securities and using the proceeds to buy British Gilts (sovereign debt) and other financial instruments would enable the BoE to achieve its objective without having to resort to wholesale money printing. In addition, if not for this sleight of hand, UK inflation would probably be even higher.

Still, this is little more than a mere accounting trick, and those funds will probably still need to be withdrawn from the money supply at some point anyway. Whether the BoE burns the proceeds or reinvests them back into foreign instruments is certainly worth pondering, but insofar as it won’t impact inflation, it is a matter of economic policy, and not monetary policy.

As Chancellor Osborn indicated, the UK will probably send these funds back abroad. In addition to providing support for the Dollar (as well as another reason not to be nervous about the upcoming end of the Fed’s QE2), this would seriously weaken the Pound, at a time  that it is already near a 30-year low on a trade-weighted basis. After falling off a cliff in 2009, the Pound recovered against the Dollar in 2010, largely due to the BoE’s shuffling of its foreign exchange reserves. To undo this would certainly risk sending the Pound back towards these depths.

On the one hand, the UK is certainly conscious of this and would act accordingly, perhaps even delaying any foreign exchange reserve accumulation until the Pound strengthens. On the other hand, the BoE is under pressure to fight inflation. It is reluctant to raise interest rates because of the impact it would have on the fragile economic recovery. The same can be said for unwinding its asset purchases. However, if it offset this with purchases of US Treasury securities and other foreign currency assets, it could weaken the Pound and maintain some form of economic stimulus. Especially since the UK has run a sizable trade/current account deficit for as long as anyone can remember, the BoE has both the flexibility/justification it needs to coax the exchange rate down a little bit.

Ultimately, we’ll need more information before we can determine how this will impact the Pound. Still, this is an indication that the GBP/USD might not have much more room to appreciate.

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Trend, Direction and Timing

It's easy to chase your tail before making a new trade. In fact, most of us don't know what to look for before we commit our capital. Simply stated, each opportunity should speak for itself. The best way to decide whether a given trade does that is to first answer a few basic questions:

- What is the trend or range intensity?
- What is the direction of the next price move?
- When will this move occur?

Concentrate on the three Cs to find the answers you need to make the trade. Recognize trend-range intensity through time-frame convergence. Predict price direction through the will of the crowd. And align market timing through range contraction.

Markets alternate between up-down trends and sideways ranges. This is true in all time frames. Price movement swings through synergy and conflict as trends collide or converge. The strongest trends emerge when multiple time frames stack up into directional movement. The most persistent ranges appear when multilayered conflict stalls price change.

Use moving average ribbons (MARs) to study trend intensity. These handy tools illustrate complex relationships through simple interactions. Start by finding where current price sits in the ribbons. Since price always moves toward or away from underlying averages, each new bar reveals characteristics of momentum, trend and time. Tie MARs together in a logical way. For example, use 20-, 50- and 200-day averages to view distinct short, intermediate and long-term trends.

The interplay between averages exposes market phases and trend acceleration. Look for a bear market when MARs flip over and the 200-day MA sits on top. Look for the bull to return when it crosses back and each MA lines up, from shortest to longest. Expect choppy action when averages criss-cross out of sequence. Price, for example, can bounce like a pinball when it gets caught between inverted averages.

Volume defines the crowd. Studying market volume has two primary functions. First, it gauges the strength of ownership and the passion of the owners. Second, it filters the crowd's divergent impulses and predicts their herd behavior. Capture this vital information with a simple volume histogram (preferably color-coded) and an accumulation indicator such as on-balance volume (OBV). Volume is deceptively simple. The lack of a clear relationship between price and volume undermines accurate prediction. Volume leads the crowd as often as it lags, but always makes perfect sense in hindsight. Examine price action closely before timing trades to a volume pattern. And move quickly to other opportunities when the crowd gives mixed signals.

Range-bound markets lower volatility and dissipate crowd excitement. Eventually congestion reaches a balance point where a new trend can begin. This cooling-off phase sounds simple, but it's very hard to trade profitably. Declining volatility fosters crowd disinterest, profit taking and indecision. The chart draws a series of narrowing range bars (the distance from bar high to low). Then a new trend explodes just when everyone turns their backs, but most miss the trade because it gathers no crowd until it passes.

Find the narrowest range bar of the last seven bars (NR7) to locate this sudden congestion breakout. Its predictive power lies in the location where it appears. NR7s work best right in the middle of congestion, or when price pushes repeatedly against a major barrier. When the signal works, it works fast and triggers a major price expansion without a pullback.

How do you trade an NR7? Place an entry stop just outside both price extremes at the same time, and then cancel one order after the other executes. Then place a stop loss at the location of the cancelled order. This takes advantage of the small pattern, regardless of the way it eventually breaks out.

You can answer the three questions with a single price chart and a few good indicators. This way you'll know what to do next with very little effort. Get on board quickly when everything converges and points to an impending move. Multiple signals reveal crowd forces that converge into intense breakouts or breakdowns. These focused time-price zones line up with the right answers at the right time.

Sumber www.tradingday.com

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