Since this blog is ultimately about trading FX and making money, it is time to take a time out from the long nuanced commentaries of the past few posts and talk about trades again. Specifically, what positions should one take, when should they be established, and when should profits be taken.
News on the fiscal cliff was muted today due to the tragic shooting in Connecticut. As a result, markets were able to consolidate and extend gains from Wednesday's Fed announcement. The Euro reached an intra day peak against USD of 1.3173, the highest since May, before closing at 1.3155 in New York. The Aussie dollar held gains as well, closing at a respectable 1.0556 versus USD. Mexico's peso swung wildly throughout the day, plunging nearly 1000 pips against USD before regaining its footing in the 12.73-12.76 range. The day's biggest mover was JPY, which experienced a bear market rally, closing up against all major peers. The Japanese yen has been under tremendous pressure as the likely winner of Japan's December 16th elections has called for fiscal and monetary stimulus to boost a Japanese economy which has fallen back into recession. Former Prime Minister Shinzo Abe of the conservative Liberal Democratic Party is poised to return to power after unexpectedly resigning in 2007 less than a year into his term amid string of foreign policy failures. Mr. Abe has now built a campaign around reviving Japan's stagnant economy. The candidate has openly criticized the Bank of Japan, and has called for "unlimited stimulus" and an inflation target of at least two percent. LDP has dominated post-war Japanese politics, ruling continuously from 1955 to 1993, and 1994 to 2009.
With polls predicting an overwhelming win for LDP over the center-left Democratic party headed by PM Noda, speculators have been establishing a huge short yen position since mid November. According the Commodities Futures Trading Commission, the market has massed a 14.3 billion dollar net short position on JPY, the largest since July 2007. While it is not certain if this development represents a true pricing in of Japan's weak fundamentals, or a speculative move by traders to profit from the elections, the evidence points to the latter. Japan's massive debt levels, loss of comparative advantage, chronic deflation problems, and aging population couple with a closed door immigration policy have been festering for decades. Only extreme external risk aversion, which has pushed some investors into the yen due to its historic role as a safe haven, has allowed the currency to achieve post war highs in the face of deteriorating internal fundamentals. In sum, the Yen, despite the considerable structural problems facing the Japanese economy, is most likely oversold in the short term, with speculators looking to make quick profits over the weekend.
As such, I expect to see USD/JPY reach 84.10-20 levels Sunday night stateside, and then sell off as the yen bears ring the cash register. Where the yen ends up after the profit taking is over will be good indicator as to the degree to which the 'conviction trade' has pushed the yen lower. Specifically, it will be very interesting to see if the yen holds its gains from the rollout of the Fed's new easing program on Wednesday.
Considering these facts, shorting the yen now with plans to take profits on Sunday, or buying AUD, CAD, or USD against the yen after the post election dip are both very attractive options. Europe also appears to be finally uniting. The best play to profit from this is to sell USD/NOK or USD/SEK on rallies. The Scandinavian economies have some of the strongest fundamentals on the Continent, well capitalized banks, and a sturdy and well regulated financial system. The Scandies also offer modest yield; NOK and SEK yield 150 and 125 bps respectively. Currently, I am short USD/SEK with a longterm target of 6.3 to the dollar. Finally, USD/MXN remains a sell on rallies, though one must be cautious as MXN is especially sensitive to news (good or bad) about the fiscal cliff. Any dip in the peso back into the 13 to 13.20 range would be a very attractive opportunity to establish or add to any long peso position.
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