Markets: The Yen Versus US Equities

A Bear Market Currency Trade: Long Yen, Short Sterling

Dec 10th, 2008 | By Frank Hemsley | Category: US Dollar & Forex Trading

There is always a bull market going on somewhere, says Frank Hemsley. As currency values are all relative to each other, a slump in one always means another is soaring. Frank says the unwinding of the carry trade means the Japanese yen is soaring against weaker currencies like the British pound. As long as stocks remain in a bear market, Frank says the yen will rise and sterling will fall.

This from Fleet Street Daily:

But there is a market where you can always make profits from others’ bullishness. I’m talking about the currency, or Forex markets.

Because each currency is measured against another one, for every bear market, there has to be a corresponding bull market.

Let’s look at sterling. You’ll be aware that the pound has been a basket case these last few months. In fact, if you look at it over the last the year, it’s been smashed against every other major currency.

Against the US dollar, sterling has fallen 26%; against the euro, it’s fallen 21%; and it’s lost 23% of its value against the Swiss franc.

Which ever way you cut it, sterling’s in a bear market. But remember, Forex is a zero sum game. While the guy holding sterling has been losing money in a ferocious bear trend, the guy on the other side of each one of these trades has been raking it in.

And what really stands out is that whilst stock markets around the world have been in bear territory, one particular currency has been on fire. I’m talking about the Japanese yen. It’s outstripped all the others by going up 40% against the pound in the last 12 months.

As stock markets have fallen, the Japanese yen has soared…

Source: Bloomberg

The chart shows the Dow in red and the Japanese yen versus sterling in black.

The yen tends to be inversely correlated to stock markets. When stock markets are strong, the yen is weak, and vice versa.

This is because over the past several years, with Japanese interest rates at zero, investors have taken advantage of cheap yen-denominated loans. They borrowed in yen and bought into higher yielding investments – e.g. other currencies, stocks or commodities to earn the interest rate difference, or ‘carry’ (hence the name, ‘carry trade’).

This was all working well for investors. They were making money by borrowing cheap… and making inflated returns. In essence, they were using leverage. Meanwhile, the act of borrowing was, in effect, the same as selling yen – so naturally this pushed the yen down in value.

It was all going so well…

Everything was fine until the US housing market blew up and spilled over into other financial markets. Investors were forced to close out their winning trades in order to cover losing ones.

We have seen a huge deleveraging of financial markets – and a rush to pay back yen loans – in other words, buying yen. This has caused the yen to rally strongly – roughly in step with the stock market collapsing.

Now, when stock markets rally – i.e. when there is an appetite for risk – then the yen is sold off to fund trades. And when the stock market falls, the yen suddenly finds favour again as a “risk aversion” trade.

We’ve seen this week that President-elect Obama’s huge infrastructure stimulus proposals have got the confidence back for stock market investors. Hence yesterday’s impressive rally in worldwide stocks (and corresponding fall in the yen).

But stock markets are not out of the woods yet – the economic data is still weak.

When equities fall, expect to see the weakest global currency (sterling) fall and the strongest (yen) rise. It’s a bull market that could run for as long as the bear market in stocks.