Has the short-term move in the Euro Yen clarified the long-term outlook?

By: Seven_Days_Ahead

For most of May and June the Yen was a strong buy against the Euro, as traders sought safe havens to protect against the Euro zone Sovereign debt crisis. At that time, the Yen and Dollar were considered safe trades, especially the Yen, even though Japan runs a very high debt to GDP ratio and continues to struggle with deflation. But unlike the Dollar, Japan runs a healthy trade surplus, has foreign exchange reserves in excess of US$1.0T and most of her government bonds are owned domestically.

The Technical Trader’s view:

WEEKLY  CHART This is an old favourite. The weekly chart shows the market struggling to trade back up through the band of resistance from the Prior Lows 112.10-113.63. It looks to have had a good attempt and failed. Look closer.

The Macro Trader’s view:
For most of May and June the Yen was a strong buy against the Euro, as traders sought safe havens to protect against the Euro zone Sovereign debt crisis. At that time, the Yen and Dollar were considered safe trades, especially the Yen, even though Japan runs a very high debt to GDP ratio and continues to struggle with deflation. But unlike the Dollar, Japan runs a healthy trade surplus, has foreign exchange reserves in excess of US$1.0T and most of her government bonds are owned domestically.

At the end of June the Euro staged a recovery, as a rescue fund was put in place by the EU/EZ/IMF and confidence began to return to the Euro zone economy, with Germany registering some very strong economic data.

But how much of that strength was a product of the Euro’s prior period of weakness, which against the Dollar has largely retraced? Moreover, now the US economy is once again in trouble, will the Euro zone economy be able to maintain the momentum it seems to have begun building, or will US economic weakness act as a drag on the Euro zone.

These are obviously questions that are now running through traders’ minds. But what then of the Yen?  Why has it suddenly strengthened so rapidly against the other major currencies? Well, against the Dollar there was no noticeable weakness, the retracement was only against the Euro. Indeed against the Dollar the Yen has made a string of multi-year highs.

But this week, as the Fed revised lower its growth forecasts for the US economy and pledged to re-invest bond purchase principle as it matures, to avoid an unintended monetary tightening, the Euro is the currency that has weakened and most noticeably against the Yen.
We judge the Yen to be the strongest of the major currencies right now. As said earlier, Japan has a strong trade surplus, its government debt is owned mostly domestically and she has a large foreign currency reserve.

These facts have been noticed by Japan’s giant neighbour China, when an official said only yesterday that Japanese government bonds are a safer investment than US Treasuries.

But there are some other reasons why the Yen is seen as a strong currency and that is due to its proximity to China. Clearly Japan benefits from growing trade ties with China as a producer of machine tools. China might be considered the work shop of the world but she still needs to import the tools to make the machines that produce her exports.

In short, the Yen looks to be a strong currency in a world where old certainties are being questioned. Economic power is inexorably ebbing east.  The US, while still the world’s largest economy, faces some very serious challenges and the Euro zone does too. Unlike the US, the Euro zone nations have pledged to cut debt and public spending, but just how durable is the Euro zone recovery?

We expect to see the Yen rally further against the Euro, as traders and investors increasingly turn to the only true hard currency left in the world. Add in the fact that the Yen also has the attraction of being something of a proxy trade for China, and the rising sun of Japan seems to be in the ascendency.  

Mark Sturdy
John Lewis

Seven Days Ahead
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Mark Sturdy, John Lewis & Philip Allwright, write exclusively for Seven Days Ahead a regulated financial advisor selling professional-level technical and macro analysis and high-performing trade recommendations with detailed risk control for banks, hedge funds, and expert private investors around the world. Check out our subscriptions.

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