JPY continues to weaken against USD and EUR, to the point that large speculators have reversed their big long commitments to JPY and are now net sellers of JPY futures. As the calendar page turned to March, JPY/USD hit JPY81.87/USD, the weakest JPY level in 9 months, with a major turning point being the BOJ's surprise JPY10 trillion expansion in its asset purchase program and the the setting of a 1% price target, which convinced hedge funds and other forex speculators they needed to be short, not long, JPY.
As the chart below shows, non-commercial speculative long JPY future positions have shrunk from a peak of 81,054 contracts (56,669 contracts net long, each contract worth JPY12.5 mm) to a net short position of 1,203 contracts, for the first time since May 31, 2011. Ben Bernake's testimony before the U.S. Congress has played down expectations for QE3 quantitative easing, while the BOJ has surprisingly stepped up to the plate with additional easing and its first price target, which Japanese politicians say should be 2%, not 1%.
|Source: CFTC, http://www.cotpricecharts.com|
Historically, the JPY/USD exchange rate has demonstrated a very close correlation with the yield spread between 2-year US and Japan government bonds. Over the past month, this spread has bottomed out and begun to re-expand, from 10bps to 20bps amid growing expectations for further spread expansion, given a perceived receding of Greek and southern Europe sovereign debt risk, and positive surprises in U.S. economic data. Assuming that the U.S. economy continues to recover albeit modestly, this spread could continue to expand.
|Source: Nikkei Amsus|
Further, the view of JPY as a "teflon" risk haven has begun to crack as Japan reported its first balance of trade deficit in 2011 in over 30 years. As demand for Japan's exports wane, real JPY demand also wanes, while there has been noticeable growth in demand for USD-denominated energy imports. Further, many domestic economists suggest that Japan's current balance of payments surplus, so far mainly supported by interest and dividend income from foreign investments and overseas subsidiaries, could also fall into deficit within the next five years, removing the structural BOP surplus argument that has long supported JPY.
|Source: Bank of Japan|
For Japanese corporate profits, JPY appreciation against EUR and in terms of real effective exchange (REE) rates has been a bigger issue, as Japanese companies are finding it difficult to hedge their EUR forex exposure with increased imports of raw materials and components from Euroland. The monthly BOJ data still show REE rates in a rising trend, and until REE rates definitively turn, there will be no real forex windfall for Japanese exporters to enjoy. Stock prices of these companies however move in real time with nominal spot rates, meaning stock prices will have already been there, done that by the time the REE depreciation shows up in corporate profits.
|Source: Bank of Japan|