Short USD/JPY?

I have been thinking about shorting USD/JPY. The market has run up sharply in the past couple of weeks, with the news outlets reporting the reason as being the BoJ’s new “inflation target”. I am not sure that this is a good reason for the market to move, nor that it is the reason the market has moved. On the former point, Mr. Shirakawa is known to be an opponent of inflation targeting and, in a recent speech, has reaffirmed his belief that the BoJ cannot end Japan’s deflation alone (he thinks the government needs to “strengthen Japan’s growth potential and growth expectations”). So it is unlikely that the “target” (“goal” is a better translation) will lead the BoJ to take the kind of aggressive action actually that might actually lead to a 1% inflation rate.

On the latter point, other factors have been in play. The main determinant of the level of USD/JPY is the spread between Japanese and US interest rates (I have used 2-year rates). Historical correlations between the two series are high over various time frames. Recent strong data in the US have caused US 2-year rates to increase a little, and Japanese 2-year rates have recently fallen a little, and hence the spread has widened fairly sharply. The latest data point is on the outside edge of a scatter plot but far from being an outlier. So the move in the 2-year spread would seem to be the basis of any explanation. USD/JPY has moved more than the change in the spread would imply, however. The explanation may be the 1% goal, but I think it is more likely the BoJ’s other recent action — the increase in its asset purchases. A monetary loosening would be consistent with a move across the scatter plot to the outer edge.

I am wondering whether I should be short USD/JPY, but I am wary of entering at current levels. Currencies are spiky and USD/JPY especially so; a relatively narrow stop could easily be taken out. At present, my stop would be around the centre of the range that the market created between October 2010 and July 2011, and it strikes me that it could easily get back there if US rates or FX market players were to get a bit ahead of themselves (I expect 2-year rates to remain generally low, but that does not preclude short-term moves). I would prefer to have a stock at a more obviously wrong level — say, towards the top of the 2010-11 range. So I am inclined to wait.

What is driving SPX upward?

Equities are driven by earnings and credit spreads. At present, trailing 12-month earnings are rising and credit spreads are narrowing — i.e., both drivers are sending the SPX upwards. My long bias in equities is based on a call on credit spreads, which I expected to be narrowed by recent central-bank action, combined with a lack of any headwind from earnings (I did not expect earnings to fall given the recent strength of the US economy and the upward direction of my US leading indicator). Credit spreads have more scope to narrow and the economy has room to grow, and thus a further rally in SPX is likely.

PIK Notes

Peacocks has issued PIK notes, a toxic form of debt that gets issued in good times. The FT quotes an analyst sounding negative on this, but I think it is positive. We are a long way from the next credit-market blow-up, and for one to happen we need a credit boom first. That would be good for the economy. The first wasp can be an indicator that summer is on its way; perhaps the first PIK note is an indicator of happier times ahead in the coming years.


  • Revised Michigan sentiment 75.3 b.e. Near post-crisis highs.
  • New home sales 321k b.e. but remains very depressed.
  • NZ trade balance turned negative again after a positive quarter last time.
  • Eurozone M3 2.5% YOY b.e.
  • Eurozone private loans 1.1% YOY d.e. This is really not a good number.

This Week

  • Pending home sales (Mon).
  • Japan retail sales (Mon).
  • Durable goods orders (Tue).
  • Case-Shiller index (Tue).
  • Japan prelim. IP (Tue).
  • Eurozone CPI (Wed).
  • US prelim GDP (Wed).
  • Global PMI’s (Thurs).
  • Eurozone unemployment (Thurs).
  • Personal income and outlays (Thurs).
  • Japan CPI (Thurs).