Mar 28, 2012

There Will be No JPY Black Swan

Everyone is talking about The Yen's Looming Day of Reckoning by Andy Xie in which he spells gloom and doom about Japan and the yen. Japan's economy has indeed been trapped in a prolonged period of sub-trend growth and deflation. The strong yen makes things worse by reducing the competitiveness of the country's exporters.

But why a catastrophic collapse? In late Dec in Japan Nov Trade Deficit Worsens - Usd/Jpy to Turn the Corner Soon we thought the government or the BOJ should take steps to weaken the yen, which would impact positively Japan's economy and its exporters, which in turn can jump-start an outperformance of
Japan's stock market. JPY weakness and NKY outperformance this year have played out according to this virtuous cycle scenario. Why should a destructive one-off massive devaluation be the only option?

Mr. Xie claims that the 1996 JPY devaluation contributed to the 1997 Asian financial crisis. What devaluation? After hitting an all time high in the low 80's in early 1995, with the bursting of Japan's property bubble and continued deterioration of the economy, the yen sold off to above 110 to the dollar by the end of next year. The process took almost 2 years and represented the market repricing the relative strength of the US and Japanese economies. Very different from the 40% devaluation in a matter of days that Mr. Xie predicts.

To conclude, from a contrarian point of view, such doom and gloom headlines should make one consider going long JPY. With equity markets threatening a correction and the trend of yen weakening stalling, it is probably a good time to short Usd/Jpy.

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