The Great Japanese Unwind?
My last crystal ball reading of market aftershocks from the tragedy in Japan has been mostly correct, in retrospect, with one big mistake: the Yen keeps surging. Apparently I underestimated the extent of Japanese repatriation, which has probably been sustained by the worsening of the nuclear situation.
FT Alphaville just posted a table listing overseas holdings by Japanese investment trusts. It doesn't provide any direct trading guidelines. For example, Japanese investment trusts own 7% of the Vietnam stock market, which has barely budged since the earthquake. But at least it provides a partial picture of the potential extent of the ongoing Great Japanese Unwind. Nobody knows how big the carry trade unwind by Mrs. Watanabe is. But it's prudent to assume that, given the high savings rate in Japan, repatriation may continue for awhile if the nuclear situation keeps worsening. Too bad for Japan Inc., since a strong yen is exactly what they don't need.
This changes the short-term (days) trade. If the situation improves, stocks would rebound strongly while the yen may drop; otherwise more of the same -- tanking stocks and surging Yen. Whether this will impact U.S. Treasuries or not remains to be seen.
But it doesn't change the longer-term outlook. Japan will surely go into recession, possibly a severe and painful one. And, since central bankers all over the world are 100% confident they can eliminate business cycles that are the healthy, evolutionary mechanism, self-correcting the fundamental flaws of the free market system, much like a forest fire, BoJ will continue printing their way into disaster. Where JGB has been at the peripheral of the bond vigilantes' radar so far, it will be at the center soon (could be in months). On this side of the pond, the Fed will of course continue printing as the economic fallout trickles in.
A big question is whether this unwind will be contagious and trigger a global one comparable to the panic in 2008. My answer is no. It is very unlikely that a nuclear meltdown, as terrible as it may be for Japan, would cause much global direct damage.
A Japanese recession would have global implications, but it would come later and slower. Precious metals and commodities will enjoy strong support by the suicidal central bankers. Granted, commodities inflation driven by excess money will kill all economies; but that's of no concern for central bankers since their goal in life is to create inflation, and their inflation detector is designed not to detect any until too late.
A commodities rebound may be delayed compared to precious metals, though, because the supply-demand argument may cause some hesitation. But people have no choice other than to continue on the moronic, suicidal path of commodities inflation, driven by moronic central bankers around the world. No doubt central bankers are very intelligent people. Problem with very intelligent people is that they can screw up much bigger and for much longer than others are capable of.
And a few things we can say are not:
- The earthquake/tsunami/nuclear-meltdown triple whammy is not bullish for Japan nor the world at large. It's hard to imagine a more idiotic argument.
- The commodities market is not driven by supply-demand at the time-scale longer than days at most.
- The yen's surge is not because it's a safe haven.
Disclosure: I am long GLD, PHYS, SLV, DBA.
Say that again Mr. Peng? A nuclear meltdown in the world's third largest economy will not trigger another global downturn? Can central bankers cushion the blow by printing potassium iodide laden paper currency? Let's get real here, if Japan implodes, the fallout will make 2008 look like a walk in the park!
Having said this, there is a tremendous amount of hysteria going on right now and a lot of it is fueled by Japanese authorities who are not being transparent with the world on what is really going on at these nuclear plants. Along with mass hysteria comes crazy market volatility. And market participants are nervously watching the yen carry trade. Fox Money reports, Yen Hits Record High Versus US Dollar:
The Japanese yen touched a new high against the US dollar Wednesday, with the greenback dropping below 80 yen, as concerns over the nuclear situation in Japan intensified, weighing heavily on US and European stock markets.
“The problem is that as the fallout from the earthquake is creating a drag on stocks,” Japanese corporations are selling stocks, said Andrew Wilkinson, senior market analyst at Interactive Brokers, and the money from those sales “is finding its way back home through dollar sales and purchases of yen.”
On Wednesday, the US dollar touched a low of 79.73 yen, a new record. The yen recorded its previous all-time high versus the dollar at 79.75 in 1995.
The dollar recouped some of its loss to trade more recently at 79.82, well below its level of 80.73 in North American trade late Tuesday.
“The nuclear situation in Japan could be out of control if the Europeans are right in their assessment, and investors are taking no chances with that,” said Kathy Lien, director of currency research at GFT, in emailed comments.
The European Union’s energy commissioner warned Wednesday that “possible catastrophic events” in Japan could be seen in mere hours, according to news reports.
The US also urged its citizens within 50 miles of Japan’s Fukushima nuclear plant to evacuate or remain indoors.
“The nuclear situation is a component of the situation in currencies,” said John Kicklighter, currency strategist for DailyFX.com, in emailed comments.
The euro traded at 110.82 yen, down from 113 yen Tuesday.
“What you have here is opposing forces on the Japanese yen: Foreign capital is leaving due to the uncertainties that persist in the economy, while funds are also being repatriated due to the subsequent carry [trade] unwinding,” Kicklighter said. “At the moment, carry unwinding is proving the larger theme, but that will not be the case forever.”
Measures unveiled this week by the Bank of Japan include an increase in the size of the bank’s asset-buying plan to 10 trillion yen ($124 billion).
GFT’s Lien said the biggest question currency traders face is whether or not the BOJ will step in and artificially weaken the yen.
“The central bank’s liquidity injections stabilized the equity market [in Japan] but failed to stop the yen from rising, she said. The Nikkei Stock Average climbed nearly 6 percent Wednesday.
“The endless superyen continues to operate -- against all odds,” said Richard Hastings, a macro strategist at Global Hunter Securities.
“Japan is going to use its muscle,” he said, taking the dollar-yen exchange rate closer to an all-time low of about 77 yen to the dollar.
“This would be bad for Japan export stocks, but it gives Japan huge buying power in forex and raw goods, helping them to rebuild,” he said.
The yen, as well as the dollar, have traditionally been seen as safe-haven currencies, and analysts have said that a likely repatriation of funds as Japan rebuilds after the massive earthquake is set to boost demand for the Japanese currency.
But while the dollar continues to lose ground versus the yen, it’s gaining ground against the euro as the European and US stock markets suffer steep declines.
“We are seeing widespread selling of equities and high yield currencies, sending currency traders back into the arms of the US dollar,” said Lien.
The euro slipped to $1.3892 versus the dollar after changing hands at $1.40 late Tuesday. The British pound traded at $1.6018, off from $1.6082.
It's also worth noting that despite what Bill Gross of PIMCO said about dumping US government securities (Cough! Watch what Bill does not what he says!), US Treasuries have rallied sharply since the Japanese crisis erupted last week as investors seek a flight to safety.
And while my fellow bloggers over at Zero Hedge have called Wednesday "The Day The Yen Carry Trade Died," I think such calls are premature and feed more hysteria. The yen carry trade isn't dead. Far from it. Commodity currencies like the New Zealand kiwi are getting roiled but this isn't exactly a surprise as risk trades are off as traders assess the news coming out of Japan. But when I hear people warning that Japan will sell all their US bond and equity holdings, I just roll my eyes and ignore the nonsense.
Finally, the question I've been getting the last few days is "should I buy the dips?". My answer to those who ask me this question is "can you stomach gut-wrenching volatility?" I can because I invest almost exclusively in Chinese solar stocks and have seen my personal portfolio swing from -60% to +80% over the last year. I just kept buying the dips and averaging down. If you can handle crazy volatility, keep buying the dips, the reflation trade is alive and kicking and we have not reached the absurd bubble phase yet (we will). If you can't handle volatility, stick to cash and sleep well at night. Below, the latest on the Japanese crisis.