Yen: Quo vadis, karaoke politics?
Summary
Much ado has been made of Japan's election results. We are a little less excited, dubbing these "karaoke politics": the Japanese chicken will keep its head firmly in the sand, and the deer will stare firmly at the headlights. After all, nobody can move the impregnable bureaucrats out of their positions of power. Indeed, we just saw some musical chairs in which "Japan's former ruling party handed parliamentary lifelines to Finance Minister Kaoru Yosano and 54 colleagues who lost seats in yesterday's record election defeat."(Bloomberg: "Record LDP Defeat Sees Party Bigwigs Resurrected as 'Zombies' ") Curiously, the word "Zombies" is of West African origin, stemming from "fetish". That morphed into Louisiana creole, meaning "phantom", and since has been debased to "dimwit". Particularly in light of the non-event of 2009, whither the yen? So what about carry trades?Topics Covered
- Why the yen must strengthen
- How to make money off this
Background
1. Why the yen must strengthen
Today's headlines would have you believe that the yen strengthened "because of" the electoral "karaoke politics" that have just occurred. So this implies that because of the election results, people will start believing in Japan, so up goes the yen, n'est pas?
We are less sophisticated: elections won't change a thing in Japan. Instead, the reason for a stronger yen has everything to do with stronger market volatility.
Here is why: when volatility falls, people put on carry trades. So for many moons, the zero interest yen was the currency of choice: you borrow it, convert it to the currency of your choice, and take a punt. By virtue of selling the yen, it gets depressed when a carry trade is put on. And carry trades are put on when volatility falls: people are more certain of the direction of things.
Applying but the most rudimentary rules of logic means that if something is true, its opposite also is true. So, if it is true that the yen falls when volatility rises, it must be equally true that the yen rises when volatility falls.
How so? Because when volatility rises, people by definition are less certain. So they scamper out of their carry trades, i.e. they unwind them. in the process, they sell the instruments that they punted in, and then sell the currency, buy back the yen that they originally borrowed, and re-pay the yen loan.
What I foresee is ever-more volatility, fueled by an ever-weaker market, the harbingers of which we saw today. Indeed I have been so bold, or stupid, as to predict an October tumble - possibly due to further rumbles in China, or in the U.S. Treasury markets, or in volatility itself... Add to this vile cocktail of unease another ingredient: karaoke politics. For now, elements of the press would have us believe that Japan's politics will change. These elements hinge their hopes on the new PM's promise (actually, he gets "elected" in the middle of September) that the bureaucrats' power will be reduced considerably. Really?
Ever tried changing a habit of yours? You know what herculean effort is required to change your own software, so how about changing the cultural and thus political software embedded in 130 million Japanese? I am afraid that the machinery, the orchestra, remains the same and the singers just change. Step in, karaoke politics.
With no fundamental political changes on the horizon,disappointment will breed uncertainty. That, in turn, will squelch consumption plans of individuals and thus investment plans of companies, so down spiral corporate earnings. The market gets jumpier on a downward trajectory.
The result is that increased market volatility in Japan must feed global market volatility. That, in turn, implies ever-more unwinding of carry trades, so up goes the yen.
2. How to Make Money Off This Idea
- Always consult your financial advisor first.
- Go long the yen against the US dollar.
- In particular, with China's growth slowing down her appetite for Australian commodities, go long the yen against the Aussie.
