Interest rates are to asset prices, like what gravity is to an apple, once said Warren Buffet. Low interest rates imply low gravitational pull to asset prices. Similarly, a loose interest regime when faced-off against a fierce monetary stance, can send the former currency deflating at an alarming clip.
This paper peeks into the Japanese macro environment. It then contrasts it with the situation in the US. The sentiments among the respective central bankers amid the macro forces at play will dictate the path ahead for the Yen.
Bank of Japan's (BoJ) "looser for longer" policy when weighed against "higher for longer" Fed’s stance, points to Yen weakening to JPY 155/USD by the end of the year.
Accordingly, this paper posits a short position in CME Japanese Yen futures expiring in December 2023 to gain from a weakening Yen with an entry at 0.0069445 followed by a target at 0.0064600 and hedged by a stop loss at 0.0074075, delivering a reward-to-risk ratio of 1.05x.
FOREX MARKETS ARE A WINDOW TO MACRO SENTIMENTS
The past two weeks have been eventful in FX markets. It has been marked by volatility and uncertainty with fresh fears of rate hikes following Fed’s hawkish tone at Jackson Hole and strong economic data. An otherwise stubbornly robust US labour market has finally started to show signs of cooling.
The fears around and the resilience of the broader US economy is evident in the performance of the DXY as shown by the chart below.
Even as the path ahead for the USD remains uncertain, its strength against the Yen looks far more certain.
RECESSION DEFYING RESILIENT US ECONOMY
The Fed has maintained a hawkish tone. Why? Fed is data driven. And the data points to a resilient US economy with inflation and consumer spending rebounding. However, last Friday's job market data finally points to some cooling.
The US labour market has shown incredible resilience in the face of a slowing economy. The data from JOLTs survey highlights that job openings in the US have declined for the last three months and now stand at a 2.5 year low but remains at elevated levels.
The job openings to unemployed ratio is at 1.51. Typically, this ratio should be between 1.0-1.2 in line with moderating inflation.
The PCE price index for July was released last Thursday which showed a higher-than-expected US inflation reading after almost a year of cooling inflation. It was not entirely surprising as a more moderate increase was expected given the moderation in base-level effects.
Crucially, core inflation rose to 4.2% from 4.1% highlighting that underlying inflation remains stubborn.
The PCE release points to consumer spending in the US 0.8% higher MoM in July, across both goods and services. Spending grew at its fastest pace in six months potentially risking renewed spike in inflation.
Fresh inflation risks in the US have been driven by rising fuel prices. Oil prices have risen due to supply cuts from Saudi Arabia. Gasoline pump prices are at its highest level for the year at USD 3.83/gallon as of end-August as per American Automobile Association.
Food prices have also been on the rise globally driven by supply imbalances.
STAGFLATION FEARS ARE SURFACING IN JAPAN
Stagnation and tepid demand best describe Japanese economy for decades now. BoJ is resolute in maintaining ultra-low interest rates in its effort to drive demand.
BoJ has had mixed success in stimulating its economy. As stagnation recedes, stagflation fears loom. Stagflation is an economic condition of stagnating economy combined with high inflation.
Inflation in Japan has been on the rise for the past year, driven by a surge in global commodities (food & fuel) and the effects of higher prices in other countries.
Loose monetary policy along with a higher deficit over the past year has weakened the Yen 5% against the USD.
With BoJ committed to further stimulation, the Yen is likely to continue weakening. Notwithstanding tweaks to its YCC (yield curve control) policy and BoJ's FX market intervention, the BoJ has reiterated that its focus is on maintaining stability rather than strength in the Yen.
Wage growth this year was driven by the Shunto negotiation in 30 years of 3.8% increase in base pay. However, real wage growth remains low. Wage growth will have to continue sustainably, rather than through sporadic, one-time, increases.
Japan is at the cusp of exiting decades of deflation. Despite CPI above 2% target, BoJ fears that it is premature to declare victory as pace of services inflation remains moderate. This might push BOJ to maintain monetary policy loose for longer to ensure that Japan doesn’t tip back into deflation.
This continued dovish stance risk pushing the USD/JPY pair to 155, forecasted Goldman Sachs FX strategists. However, if BoJ pivots to being hawkish, JPY is expected to strengthen to 135/USD.
TRADE SET UP
Using CME’s Japanese Yen Futures, investors can secure exposure to the Yen. Each lot provides an exposure to 12.5 million Japanese Yen with exchange maintenance margin requirements of USD 3,300 per lot (as of September 4th). Each pip expressed as 0.0000005 per JPY increment delivers a P&L of USD 6.25.
The proposed trade set up comprises of short position in Japanese Yen Futures expiring in December 2023 (6JZ3) with an entry at 0.0069445 followed by a target at 0.0064600 and hedged by a stop loss at 0.0074075, delivering a reward-to-risk ratio of 1.05x.
• Entry: 0.0069445 (~JPY 144/USD)
• Target: 0.0064600 (~JPY 154.8/USD)
• Stop: 0.0074075 (~JPY 135.0/USD)
• Profit at Target: USD 6,056.25 ((/0.0000005 = 969 pips x 6.25)
• Loss at Stop: USD 5,787.5 ((/0.0000005 = 926) pips x 6.25)
• Reward-to-Risk: 1.05x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com/cme/.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
This paper peeks into the Japanese macro environment. It then contrasts it with the situation in the US. The sentiments among the respective central bankers amid the macro forces at play will dictate the path ahead for the Yen.
Bank of Japan's (BoJ) "looser for longer" policy when weighed against "higher for longer" Fed’s stance, points to Yen weakening to JPY 155/USD by the end of the year.
Accordingly, this paper posits a short position in CME Japanese Yen futures expiring in December 2023 to gain from a weakening Yen with an entry at 0.0069445 followed by a target at 0.0064600 and hedged by a stop loss at 0.0074075, delivering a reward-to-risk ratio of 1.05x.
FOREX MARKETS ARE A WINDOW TO MACRO SENTIMENTS
The past two weeks have been eventful in FX markets. It has been marked by volatility and uncertainty with fresh fears of rate hikes following Fed’s hawkish tone at Jackson Hole and strong economic data. An otherwise stubbornly robust US labour market has finally started to show signs of cooling.
The fears around and the resilience of the broader US economy is evident in the performance of the DXY as shown by the chart below.
Even as the path ahead for the USD remains uncertain, its strength against the Yen looks far more certain.
RECESSION DEFYING RESILIENT US ECONOMY
The Fed has maintained a hawkish tone. Why? Fed is data driven. And the data points to a resilient US economy with inflation and consumer spending rebounding. However, last Friday's job market data finally points to some cooling.
The US labour market has shown incredible resilience in the face of a slowing economy. The data from JOLTs survey highlights that job openings in the US have declined for the last three months and now stand at a 2.5 year low but remains at elevated levels.
The job openings to unemployed ratio is at 1.51. Typically, this ratio should be between 1.0-1.2 in line with moderating inflation.
The PCE price index for July was released last Thursday which showed a higher-than-expected US inflation reading after almost a year of cooling inflation. It was not entirely surprising as a more moderate increase was expected given the moderation in base-level effects.
Crucially, core inflation rose to 4.2% from 4.1% highlighting that underlying inflation remains stubborn.
The PCE release points to consumer spending in the US 0.8% higher MoM in July, across both goods and services. Spending grew at its fastest pace in six months potentially risking renewed spike in inflation.
Fresh inflation risks in the US have been driven by rising fuel prices. Oil prices have risen due to supply cuts from Saudi Arabia. Gasoline pump prices are at its highest level for the year at USD 3.83/gallon as of end-August as per American Automobile Association.
Food prices have also been on the rise globally driven by supply imbalances.
STAGFLATION FEARS ARE SURFACING IN JAPAN
Stagnation and tepid demand best describe Japanese economy for decades now. BoJ is resolute in maintaining ultra-low interest rates in its effort to drive demand.
BoJ has had mixed success in stimulating its economy. As stagnation recedes, stagflation fears loom. Stagflation is an economic condition of stagnating economy combined with high inflation.
Inflation in Japan has been on the rise for the past year, driven by a surge in global commodities (food & fuel) and the effects of higher prices in other countries.
Loose monetary policy along with a higher deficit over the past year has weakened the Yen 5% against the USD.
With BoJ committed to further stimulation, the Yen is likely to continue weakening. Notwithstanding tweaks to its YCC (yield curve control) policy and BoJ's FX market intervention, the BoJ has reiterated that its focus is on maintaining stability rather than strength in the Yen.
Wage growth this year was driven by the Shunto negotiation in 30 years of 3.8% increase in base pay. However, real wage growth remains low. Wage growth will have to continue sustainably, rather than through sporadic, one-time, increases.
Japan is at the cusp of exiting decades of deflation. Despite CPI above 2% target, BoJ fears that it is premature to declare victory as pace of services inflation remains moderate. This might push BOJ to maintain monetary policy loose for longer to ensure that Japan doesn’t tip back into deflation.
This continued dovish stance risk pushing the USD/JPY pair to 155, forecasted Goldman Sachs FX strategists. However, if BoJ pivots to being hawkish, JPY is expected to strengthen to 135/USD.
TRADE SET UP
Using CME’s Japanese Yen Futures, investors can secure exposure to the Yen. Each lot provides an exposure to 12.5 million Japanese Yen with exchange maintenance margin requirements of USD 3,300 per lot (as of September 4th). Each pip expressed as 0.0000005 per JPY increment delivers a P&L of USD 6.25.
The proposed trade set up comprises of short position in Japanese Yen Futures expiring in December 2023 (6JZ3) with an entry at 0.0069445 followed by a target at 0.0064600 and hedged by a stop loss at 0.0074075, delivering a reward-to-risk ratio of 1.05x.
• Entry: 0.0069445 (~JPY 144/USD)
• Target: 0.0064600 (~JPY 154.8/USD)
• Stop: 0.0074075 (~JPY 135.0/USD)
• Profit at Target: USD 6,056.25 ((/0.0000005 = 969 pips x 6.25)
• Loss at Stop: USD 5,787.5 ((/0.0000005 = 926) pips x 6.25)
• Reward-to-Risk: 1.05x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com/cme/.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
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