Lesson 2: A Traders Introduction to the Yen, Part II
Lesson 2: A Traders Introduction to the Yen, Part II
In our last lesson we began our discussion on on the Japanese Yen, with a look at the history of the Japanese economy, including the build up of what became one of the biggest asset price bubbles in history. In today's lesson we are going to continue this discussion by examining what happened from the early 1990's on from a monetary policy and economic standpoint, so we can understand the fundamental foundation on which the Yen sits today.
In 1989 the Bank of Japan (BOJ) began to raise interest rates, and the government instituted limits on total bank lending to the real estate sector, to try and reign in speculation which was driving stock and real estate prices to astronomically high levels. While the central bank was hoping to simply take the foot of the gas and tap the breaks on the economy, unfortunately the markets reaction was drastic, resulting in a stock market and real estate crash starting in 1990.
This was a "perfect storm" so to speak for the Japanese financial system and economy, as the effects of decline in real estate and stock market prices started a chain reaction, which reverberated throughout the economy and whole financial system. The first and perhaps most important thing to understand here, is that the economic slowdown, combined with drastic falls in the stock and real estate markets, caused the financial position of Japanese banks to rapidly deteriorate.
Much of the speculation that was sending real estate prices so high was being driven by loans from Japanese banks, which took the land they were making the loan on as collateral. As the quality of the loan was thus tied to the value of the real estate backing that loan, as real estate prices fell off a cliff so did the quality of the bank's loan portfolio's.
Secondly, large Japanese institutions such as banks cooperate with one another in Japan, and as a result of this Japanese banks hold large quantities of each others stock. Holdings of stock are considered an asset for the banks and were included in the banks capital numbers, which basically define how financially solid a banks balance sheet is. As the value of these stock holdings tumbled lower, so did the bank's capital position, putting further pressure on the stability of the individual banks in Japan, and the Japanese Banking System as a whole.
Thirdly, as the economy slowed as a result of all this, the individuals and corporations who had received loans began to have a harder time making their payments, further deteriorating the quality of the bank's loans, and stability of the banking system.
At least partially as a result of weak corporate governance, most will argue that Japanese banks did little to adjust to the financial difficulties they now faced, instead preferring to wait for stock and real estate prices to move back towards their pre bubble bursting levels. The government also did little to address the problem until 1995, when it became clear that without government intervention massive bank failures would result.
This history is important to us as traders for two reasons:
1. Reforms aimed at returning the stability of the Japanese financial system are still ongoing today, and it is these financial and structural reforms that traders watch closely when determining the fundamental direction of the Japanese Economy.
2. Japanese consumers, many of whom had lost large sums of money in the real estate and stock markets, lowered consumer spending significantly, resulting in prices actually starting to decrease towards the end of the 1990's, something which is known as deflation.
While many argue that the Bank of Japan acted too late they did eventually respond to the economic weakness with interest rate cuts driving interest rates in Japan down from over 8% in 1990, all the way to zero percent in 1999. While the Bank of Japan has increased interest rates in Japan to .5% since then, this is still by far the lowest rate of any of the the major economies of the world. As a result of this it is very cheap to borrow Japanese Yen, making it the primary funding currency for the carry trades, which we learned about in module 3 of this course. One cannot fully understand and anticipate movements in the Japanese Yen, without a full understanding of the carry trade, so if you have not do so already I encourage you to go back and review the three lesson series in Module 3 on the carry trade.
That's our lesson for today. In tomorrow's lesson we will wrap up our lesson on the Yen with a look at the history of Bank of Japan interventions in the currency market, and the major economic indicators which move the currency.
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WEEKLY Forex Economic Calendar: 24 Feb Fri
13:30 CA- CPI
15:00 US- New Homes Sales
15:00 US- final Univ of Mich Survey
13 Feb Mon
No Major Data 27 Feb Mon
13:30 US- Durable Goods 28 Feb Tues
07:00 DE- Retail Sales
10:00 EZ- flash HICP
13:30 US- GDP
15:00 US- CB Consumer Confidence
15:30 US- EIA Crude 1 Mar Wed
All Day- final Mfg PMIs
08:55 DE- Jobless
13:30 US- PCE Deflator
15:00 CA- Bank of Canada Decision
15:30 US- EIA Crude
19:00 US- Beige Book 2 Mar Thu
13:30 US- Weekly Jobless
23:30 JP- CPI 3 Mar Fri
All-Day SVC PMIs
In response to the latest Fed policy Minutes yesterday, some are pushing the date for the next rate hike back to May. I don't see this sentiment shift in Fed Funds futures. In respnse to this chatter, the EURUSD is trading well of its Tuesday lows. I still feel the Fed hikes in March barring a significantly weaker than expected February jobs report on March 10. The FOMC Minutes left open the door to the RISK of a Rate hike as early as the March 15 FOMC ("very soon"). However, no clear signal was sent.
The Fed appears to want to embark on a policy "normalization" soon. Traders have trouble believing the Fed has the courage to go through with a rate hike. For Yellen build any market credibility, she should hike rates soon.
Fed Funds futures odds for a March Fed rate hike are only 38% (34%), suggesting they are skeptical. Markets now place the odds for rate hikes by June at 112% (116%). That is 100% for one hike (March?) plus 12% for a second move, or possibly something in-between.
On top of the Fed muddle, investors have begun to worry about the risk from key leadership elections in Europe over the rest of the year. Many worry about the possibility of a swing to right as has been seen in the U.K. (Brexit) and U.S. (Trump). Such could be a challenge to the status quo in the EU.
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