One Trade To Rule Them All

If you ever make the (perilous) decision to spend every waking hour immersed in the ebb and flow of global asset prices, you’ll discover over time that the prevailing market zeitgeist often ends up manifesting in one trade, which becomes emblematic of the times.

That’s not to say other trades don’t reflect the same conditions. It’s just to say that there’s often a quintessential example, so to speak, which encapsulates the macro theme du jour.

Currently, that trade is long USDJPY. The yen’s worst year on record (figure below) reflects the dollar’s inexorable ascent, but it’s not “just” a dollar story. It’s also a policy divergence story or, more aptly, the final chapter in a longer story about central bank hubris. In addition, it’s a terms of trade story, and a story about how a negative terms of trade shock can create a self-fulfilling prophecy, as a deteriorating trade balance piles pressure on the currency, which in turn means ever higher import bills. Implicit in that story is the tale of 2022’s commodities shock. And so on.

Other assets tell the same stories, but the yen encapsulates them. This week, as the Fed reiterated its intention to persist in rate hikes until “the job is done” on inflation, the yen careened lower still as the BoJ, unbowed, conjured more yen to defend the bank’s cap on bond yields.

Haruhiko Kuroda’s defense of the BoJ’s yield-curve control regime is seen as a last stand — Kuroda is the lone dovish holdout in a world of born-again hawks.

USDJPY’s parabolic ascent was already one of this year’s biggest macro stories, but recently, it became shorthand for anything and everything to do with the dollar’s “no prisoners” rally, which steamrolled everything in its path, from Asian FX to the euro to sterling to equities to oil. In better times, USDJPY rallies were risk-on events, but in a crisis, there’s only one true safe haven — and it’s not the yen.

All of this means that, paradoxically, a snapback rally in the yen would represent a risk-on episode, at least initially. That was part of what happened Friday, after Kuroda (begrudgingly, one imagines) admitted that “sudden moves in foreign exchange rates are undesirable.”  “A two- to three- yen move against the dollar in a single day is very sudden,” he added.

Yes, it is. Before the weekend, Hirokazu Matsuno, Chief Cabinet Secretary, emphasized that this week’s yen moves were excessive. All options, Matsuno said, are on the table. That was presumably a reference to intervention, not to the overnight abandonment of yield-curve control. That “option” probably isn’t on the table yet, but it may be soon. Because, as one former BoJ official told Bloomberg, “intervention is very difficult as it concerns the US too.” A coordinated intervention set against a belligerent Kuroda who continues to buy bonds to defend the yield cap has the potential to create a juxtaposition too absurd for markets to countenance.

In the meantime (i.e., between now and some fateful day in the not-so-distant future when a BoJ policy shift sends shockwaves across global markets), intermittent yen rallies on intervention speculation are risk-on episodes to the extent they’re mirrored by incremental dollar weakness, taking the edge off what’s felt like a pressure cooker environment. Friday’s rebound was very large (figure below) and, ironically, very “sudden.”

I included annotations, but some readers won’t need them. The yen’s Friday rally was on par with gains seen following July’s US CPI report and the July FOMC meeting, both of which stoked speculation about a Fed pivot.

“The leader of the ‘FCI tightening trade — the US dollar — is getting rinsed after Kuroda verbally intervened,” Nomura’s Charlie McElligott said.  “The dollar getting mushed is allowing for a substantial ‘pressure valve release’ in risk assets,” he added.

Again and again over the half-dozen years I’ve been writing for public consumption, I’ve reiterated that understanding a given day’s price action requires a holistic view encompassing everything from geopolitics to macro considerations to the most esoteric market structure minutiae. Consider the implications of a weaker dollar triggered by an unwind (fleeting or not) of stretched yen positions: It’s a catalyst for a relief rally in stocks, which in turn acts as a match on all the dry kindling scattered about in the wake of downside hedging in options.

“The optics are powerful here,” McElligott went on to say Friday, describing a “cross-asset financial conditions ‘easing’ impulse” tied to pressure on “macro trend trades” — trend trades like USDJPY.

“As it relates to equities, the scenario I’ve written about in recent days — this ‘fuel for a melt-up’ thanks to recent accumulation of dynamic shorts and downside hedges picking up delta in the options space on top of systematic fund signal and positioning dynamics — could make for another ‘squeezy’ push, with flows that will be ‘buyers higher’ from here,” Charlie wrote, in the same note.

BlueBay, which this year bet the BoJ would be compelled to abandon YCC, unveiled a long yen position. “After crossing 140, the move in the yen appeared to accelerate and we projected authorities in Japan would want to stem this,” CIO Mark Dowding said. Dowding called the position “moderate,” but suggested the firm would double the bet if USDJPY reached 147.50.

Dowding in June described Kuroda’s ongoing defense of the cap on 10-year JGB yields as “untenable.” At least some Japanese officials outside the BoJ may agree. I’ve repeatedly suggested that attempting to break the BoJ is a fool’s errand. At this point, though, I’d be remiss not to acknowledge the possibility that Kuroda will be forced to relent. A Friday meeting between Kuroda and Prime Minister Fumio Kishida was the first since June.


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