
I would say the answer is a resounding maybe!
I once said that John Percival, editor of the Currency Bulletin, has likely forgotten more about currency trading than most of us will ever know. I have been a reader of John’s newsletter for over 20-years. I have learned a great deal from him, through his writings. Here is an example of his insights which I took from a very beaten up copy of his book, The Way of the Dollar, published back in 1991.
In all markets, price extremes are usually attended by a consensus that the trend, be it up or down, will continue; and by a peak of speculation in line with the trend. Hence the excruciating paradox of financial markets, that sentiment is most bullish at the peaks when prices have only one way to go which is down; and most bearish at troughs vice versa: at the top there’s no one left to buy, and at the bottom no-one left to sell. This paradox is absolutely central to working of financial markets and we need all the help we can get to understand it so thoroughly that it becomes part of our nature. The more bullish things are, the more bearish they are.
Bullishness is born as hope in the midst of despair. Hope swells to confidence and confidence swells to euphoria, and the process contains the seed of its own destruction and the birth of the opposite, fear. Fear is nurtured by falling prices and the two feed on themselves until they swell to despair. And so the cycle is completed—and ready to begin again with the birth of hope. This is the way things are and the way they have to be. We haven’t understood the process until we have grasped that. The despair creates the price trough: the price trough creates the despair. The price extreme is the definition of the extreme of despair, which is in turn, by definition the moment when hope comes to prevail; hope feeds and is fed by rising prices until the peak of price and euphoria leave prices with only one way to go, which is down. This circular process underlies every price fluctuation in free markets from the smallest one measure in seconds or minutes to the largest measured in years or decades. So it has always been and so it will always be, because it must be.
Why am I sharing this? It’s the pre-requisite for my little quiz. Can you think of a currency now that seems to fit within John’s paradigm of a price extreme? If you said the Japanese yen, I would agree. Here’s why…
1. Every commentator worth his “gift of hindsight” now thinks the yen is toast into eternity. Keep in mind, eternity is a long time and there can be a lot of ebb and flow in between.
2.
I am not sure it is accurate to say that “everyone who wants to be short yen is already in the trade,” but I think we are darn close to some type of sentiment extreme based on open interest levels in the Japanese yen currency futures.
a.
Two points to consider in the Japanese yen futures chart below:
i. Remember how the EVERYONE told us that it was a virtual “layup” trade to go short the yen and use those funds to buy some other higher yielding vehicle, aka the yen carry trade? Well, those “gift of hindsight” commentators failed to see the global credit crisis dead ahead. Before this carry trade viciously unwound, we saw an all-time high in open interest levels in Japanese yen futures; that did indicate that everyone that wanted to be short really was short.
ii. Fast forward to today. Everyone seems to hate the yen. And though the open interest positioning is quite as extreme, it is the highest on record except for the carry trade unwinding period. So, it is fair to surmise we are near some type of extreme. Mr. Market loves extremes. Mr. Market loves one-way bets. Keep this in mind the next time Kyle Bass tells you it is “guaranteed” the yen will weaken more. He may be right. But during a trend it’s often difficult to separate luck and brains. That is not to suggest Mr. Bass isn’t brainy. Indeed he is. He tries hard to prove it, as he talks about such things as duration and convexity in Japanese government bonds. And if that doesn’t impress you, I don’t what would.
Is that it Jack? Is that all you got? Well, no. I have a little chart that I shared with the Members of my Black Swan Forex service today that indicates just maybe something called “yield differentials” are changing in favor of the yen. We can’t forecast interest rates, as Mr. Percival is fond of saying. And even if we could, we can’t be sure of the currency reaction. That being said, this correlation change in US versus Japan yield spread is interesting and should give all those yen bears something to think about:
Keep in mind the chart below is in $-yen terms (spot forex market); that is opposite to the chart above which is the futures market, which is in yen-$ terms…
US 10-yr – Japan 10-yr Yield Spread versus $-yen: This chart shows the yield differential is still positive for the US but now moving in the Japan’s favor. Also notice till recently the tight correlation between USD/JPY (yellow line) and this spread? Is it time for $-yen to catch up on the downside?
Is it time to buy Japanese yen futures or sell USD/JPY in the spot market? The short answer is a resounding maybe. I think we can say a few things with some confidence (but never with as much confidence as the “gift of hindsight currency analysts” that don’t really trade currencies for a living):
1) 2) 3) 4)
We are either at, or very close to, a sentiment extreme in the Japanese yen. The yield differential for the yen is improving based on the 10-year benchmark The Japanese economy is growing again and faster than expected Money is flowing into Japan to get access to Japanese stocks and growth
Given that set of variables, the probability of at least some multi-week change in trend could be in the making. And that’s all we can ask for. For in the end trading is simply a probability bet. Nothing more and nothing less…
Jack Crooks Black Swan Capital www.blackswantrading.com info@blackswantrading.com