T2W Trading Community

Shorting the Japanese Yen has been one of the best and easiest Forex trades over the past six months. Japan's anemic benchmark interest rate of 0.25% makes it an easy target for the "carry trade", allowing Yen bears to collect interest on their trades. Banks, hedge funds and other traders have shorted JPY vs. higher yielding currencies such as the Great Britain Pound, the New Zealand Dollar, the Australian Dollar, and the Euro to take advantage of this interest rate differential. This has ignited a downtrend in the Yen, which has been exacerbated as these institutional traders add to their short positions. Fears that the Bank of Japan would embark on a campaign of interest rate hikes, which would make the carry trade less viable, has proved unfounded thus far.

Weakness in the Yen makes Japanese goods cheaper to overseas buyers, and boosts the sales and profits of Japanese exporters. As these goods become cheaper, competitors from the U.S., U.K., Europe, and elsewhere find it difficult to compete in the open market. Manufacturers from these countries then pressure their governments, which in turn pressure Japan to "do something" about the weak Yen.

And so the stage was set as we entered this past weekend's Group of Seven (G7) meeting. Would the G7 countries shine a spotlight on Japan and the weak Yen? Would there be a call for action to strengthen the Yen, or a change to the official G7 statement?

In a word, no. Sure, there were comments that warned of the dangers of the weak Yen, especially from European officials, who have been particularly vocal about the potential damage that their economies may suffer due to weak demand for European exports.

The official G7 statement warned traders that Japan's economy is "on track". The statement implies that the Yen should not be weak because the Japanese economy is not weak. The President of the European Central Bank, Jean-Claude Trichet, tried to "jawbone" the currency markets, suggesting that the carry trade is dangerous. "One-way bets in the present circumstances would not be, it seems to us, appropriate. We want the markets to be aware of the risks they contain," he said.

Does this mean that Trichet is suddenly a currency trader's best friend, looking out for our best interests and protecting us from risky trades? Of course not, he is simply doing his best to create strength in the Yen, which is in the best interest of Europe. Judging from the currency market's reaction to the G7 statement and comments, he has not succeeded.

Far from being frightened by the sounds emanating from Trichet and other officials, currency traders are emboldened by the failure of the G7 to act on the Yen in any meaningful way. Despite the intention of the statement, it is being interpreted as a green light to resume shorting the beleaguered currency. In fact, soon after the conclusion of the meeting, the Euro/ Japanese Yen currency pair (EUR/JPY) was trading well above 158.00, just a few pips below its eight-year high (see figure 1).

Figure 1: EUR/JPY tests multi-year highs just after conclusion of the G7 meeting Source: Saxobank.com.

The damage was widespread, as even the U.S. Dollar flexed its muscle against the woeful Yen. The USD/JPY pair floated just below 122.00, which last week was breached for the first time in over four years (see figure 2).

Figure 2: USD/JPY trades near last week's high, which represents a new four-year high. Source: Saxobank.com.