Thursday, February 19, 2009

Turning Japanese

Working from home, as Macro Man is doing in the aftermath of his injury, presents a unique set of challenges. While he remains in contact with his colleagues, counterparties, and contacts on a real-time basis (thanks to the miracle of modern technology), it is still all-too-easy to feel out of the loop, especially when it come to the give-and-take of the quotidian on-the-desk banter.

Still, there are some benefits to working in relative isolation. It certainly allows for introspection and a contemplative mien that is difficult to achieve on a trading desk. For example, Macro Man has discovered which song he has listened to more than any other on iTunes (Bohemian Like You, 105 times). That's information that he just couldn't get in the office, no matter how hard he tried. (As you can probably tell, Macro Man is attempting to accentuate the positives of his injury.)

Macro Man has also found his thoughts straying to Japan in recent days. It's been a while since he has written about Nippon, largely because the country has sunk swiftly into irrelevance, a mere side show when compared to the financial crisis Big Top. The yen has rallied sharply over the past year, not because of any particular merit of Japan, but largely because the rest of the world is turning Japanese (no growth, rising savings, and zero interest rates.)

And yet....Japan is managing to to re-insert itself into the global market debate through sheer force of economic decrepitude. Much like the Asian nations profiled yesterday, Japan's economic trajectory stinks. As noted in the comments section yesterday, Q4 real GDP in Japan shrunk by a resounding 12.7% q/q annualized. That's the stuff of depressions. Indeed, y/y nominal GDP in Japan (Macro Man tends to focus on nominal GDP given the distortions caused by Japan's GDP deflator) has sunk below the depths plumbed during the Lost Decade, the nadir which effected the rise of the reforming Junichiro Koizumi.
Morgan Stanley's Stephen Jen articulated an interesting concept a few years ago with respect to the JPY, citing the "economic equilibrium" level and the "capital account equilibrium" level. For most of Macro Man's career, the former has been well below the latter, as Japan has run a tasty current account surplus while exporting zillions of yen worth of capital. On the rare occasions where the two equilibria have aligned, as in 94-95, the moves in the yen have been explosive.

Perversely, however, as the rest of the world has turned Japanese, the directional bias of the two equilibira has flipped-flopped. Even as Mrs. Watanabe and her institutional brethren have brought money home in droves, thereby lowering the USD/JPY capital account equilibrium exchange rate, Japan itself has "turned American", if you will, and its once-impervious external surplus has withered into deficit.

As a result, the economic equilibrium USD/JPY has drifted well north of current levels. How far north is open for debate, but the chart below shows a simple overlay of the leading relationship between Japan's trade balance and the yen. On this basis, the economic equilibrium level for USD/JPY would appear to be literally off the charts- to the topside.

Now, Macro Man isn't suggesting that USD/JPY is going to 150 in short order, if at all. Yet the trend in Japan's external surplus is a legitimate one, and Macro Man has heard some rumblings that Japanese exporters are over-hedged. If that's the case, then we could probably expect them to become net buyers of USD (and other currencies) and sellers of yen into fiscal year end.

At the same time, Mrs. Watanabe now finds herself long multi-year trade-weighted highs, naturally. While Macro Man doesn't expect a return to the care-free carry-trading days of yesteryear, it wouldn 't come as much of a shock for Japanese retail to swing back to shorting the yen, especially if some interesting chart points are broken.
Source: Barcap

So despite the ongoing travails of equities generally and the financials in particular, Macro Man is sensing a growing desire amongst Japanese and gaijin punters alike to have a go at selling the yen. Critically, positioning is skewed the other way, with market positioning embedded long yen.

Perhaps the last word on the subject should come from Japan's (former) finance minister, Shoichi Nakagawa. Say what you will about Paulson, Geithner, Steinbrueck, and Darling (and Macro Man has said plenty!) least none of them were driven to the bottle:


FX said...

The flock is getting ready to migrate into this trade and we are about to see the the tried and true yen "global risk aversion" replaced by yen "local risk aversion" trade If you take a step back its actually rather humorous on many levels.

Anyway, I agree its time to start building into yen shorts.

Thanks for your blog, you do a nice job with it.

Yohay said...

So, are we seeing a return of carry trades? AUD/JPY looks lucrative.
I also like your blog and writing style very much.

Adrem said...

Spot on again MM. If you look at the period Jan94-Jan95 on your chart it is uncannily like the current position.

NordicDude said...

Indeed, it would appear that net outflows are indeed gathering pace. The latest data from the MOF shows a 5th consecutive week of outflows from Japanese residents into foreign bonds.

However, the key driver for USDJPY is rate differentials (just look at the correlation over the past couple of years between USDJPY and US-Japan 3yr swap differentials). With both US and Japanese policy rates effectively at zero, differentials are likely to be driven both by expectations about the impact of the central banks’ quantitative measures on yields, and moreover by equity market movements (as these tend to move US rates more than those in Japan).

Hope you have a speedy recovery MM...

Anonymous said...

To infinity and beyond....

Anonymous said...

You sound like Bridgewater.

Oregon Guy said...

Dandy Warhols - my 17 year old daughter is impressed. She thought financial types were hopelessly square.

Modest Mouse is at the McDonald in Eugene Friday night. Should be fun. I'll be in the back, with earplugs.

Best luck for a speedy recover. Your content is interesting, the style is even better.

AD said...

i get different data (for the same time frame) for japan's trade surplus/deficit... what exactly does "TRADE" refer to in your graph vs. usdyen (lagged)? Thanks

RebelEconomist said...

It's not much perhaps, but I think one positive aspect to the Nakagawa debacle is that his replacement is Yosano, who is known for wanting fiscal reform in Japan.

I hope your skiing injury gets fixed before next season MM. I hurt myself in Val Thorens on a Friday too - as the end of the week approaches, you get more reckless.