Japan's yen has been one of the world's worst performers this year, and the advisory and analyst teams at Laurence Holdings Group believe that weakness could continue for the rest of 2021 and well into 2022.
1. Central Bank Monetary Policy Divergence
Financial market participants have paid keen attention to a recent remark by Bank of Japan (BoJ) Governor Haruhiko Kuroda suggesting that the central bank will continue its negative interest rate policy until at least 2023.
The BoJ is the developed world's most dovish central bank. Unlike other major central banks that are starting to face inflation risks and contemplating a withdrawal of emergency pandemic stimulus, the BoJ has been grappling with deflation and loath to publicly suggest any tapering. (Source: Reuters)
Meanwhile, the Federal Reserve signaled a rate hike could happen as soon as 2022 and tapering and could start in November during it September FOMC meeting.
If history is any guide, every time we see this kind of monetary policy divergence between the BoJ and the Fed, the Yen depreciates at least 10% against the Dollar.
2. Bullish Japanese Equity Market = Weaker Yen
Yen's safe haven status: When panic moves across the world like during the March 2020 Covid-19 market crash, there are only a few places to take shelter. These are referred to as “safe havens”. Because traders and investors know to seek refuge in these places, they can quickly become very crowded. The increased demand therefore often sends their values soaring.
In a report by Reuters in 2019, Japan has held the position as the world’s top creditor nation (only after China) for nearly three decades, heavily buying bonds issued by other governments. Additionally, direct investments abroad by the Japanese government and Japanese businesses are 3-4 times bigger than Japan's GDP. When panic hits the markets, many of the bonds and overseas investments will be offloaded and converted back into yen, driving up demand for the currency.
In our opinion article Is Japan At the Beginning of a Major Bull Market?, we discussed the possibility that the TOPIX is at the beginning of a major bull run. Because of the safe haven status of the yen, historically, there has been an inverse correlation between global (especially Japanese) equity markets and the yen. That correlation translates into "JPY is at the beginning of a major bear market".
3. Technical Outlook of JPY Currency Pairs
Below is the monthly candlestick chart of the USD/JPY. We can see that overall, the USD declined against the JPY (JPY appreciation) for the 16-year period between 1998 to early 2014.
The greenback broke above the descending trendline in 2014 and rallied over 20% against the JPY, then in 2016, it went down to retest the broken trendline again (held above it) and started to rally again. However, from a long-term trend perspective, the USD/JPY became an "non-event" between 2017 and 2021: the pair traded in sideways consolidation mode as there were very little monetary policy divergence between the Fed and the BoJ.
Now let's zoom in to the weekly candlestick chart of the pair.
We can see the pair has been trading in a descending triangle between 2017 and 2021. However, in early 2021, the pair broke out and closed above the triangle with strong momentum, and went down to retest the broken triangle, then consolidated during summer months. In September, a pick up in trading volume pushed the pair to start rallying strongly to the upside again.
Therefore, we can see from a technical analysis point-of-view, the USD/JPY chart agrees with our fundamental analysis for the bearish yen scenario.
Is USD the only major currency rallying against the Yen? The answer is no.
Euro also broke above the 13-year-long descending trendline against the Yen.
Aussie dollar also broke above the 6-year descending trendline against the Yen.
With all our fundamental, technical and market correlation analyses pointing to a weaker Japanese Yen, shorting the Yen becomes one of LHG's highest-conviction investment ideas for the rest of 2021 and well into 2022.
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