If a second round of global economic weakness occurs, the pressure for competitive currency devaluations will rise. The Swiss have already begun to devalue their currency and now we turn to the markets to tells us who may be next. Over the weekend, the G7 met and paid a bit of lip service to the idea of a strong dollar. At the same time, Japan was changing its tune about a strong Yen.

The new Japanese government is intent upon moving Japan away from an export economy. The first step in their plan was to let the Yen strengthen and encourage business to focus on domestic demand. The fatal flaw in this strategy is that major economies are not overhauled in a weekend. Moving Japan from an export economy to one that is driven by domestic demand is a decades long process. Moreover, such an ambitious goal may prove impossible in the age of globalization.

The Japanese government (DPJ) changed its tune of a strong Yen when Toyota announced its profits were being squeezed by a strong currency. The quick about face by the DPJ suggests they understand where their bread is buttered.

Given the reversal of attitude and the cries for help from Toyota we believe that the Yen could be the next currency to weaken v. the dollar.

USDJPY Spot – Daily Chart

The FX markets appear to agree with our conclusion and have provided a wonderful risk/reward opportunity to add to our short Yen position. We already hold a short position in FXY and intend upon adding to that position on weakness. If FXY trades below $110 we shall add and assume a full short position in the Yen.

Disclosure: Short FXY