Enzio's Clock

This June we discussed North Korea a couple of times.  One suggestion was to sell the yen on 22nd June.  Luckily, we have been right: it has fallen by about 1.2 per cent over the past month since then, or by an annualized  8.9%. 

Being a student of von Hayek's and thus of Popper's, I am a great believer in "pattern predictions": instead of trying to get the right level or value going forward, we stay with the humbler objective of getting the right direction, e.g. "stronger" or "weaker". Not to say that this has rendered me infallible; indeed, if you had done the opposite of what I have been advising on stock markets - to sell - you would be far wealthier by now... C'est la vie. my role is to help make you think, as nobody ever can be consistently right.

One key driver of the yen is the direction of the American stock market.  Here is a broad time line of what has happened to this market and thus to the yen. Just to keep things simple, a "+" means that the unit (the U.S. market or the yen) has strengthened; a "-", logically, means the opposite. For the sake of brevity, I label the months with numbers; thus, a "2" denotes "February and a "7" stands for  July. Here is a fuzzy road map upon which we can base a pattern prediction:

Until the end of 2008, the pattern was easy: both the market and the yen went in the same direction. For instance, from February - July 2007, the market rose and the yen strengthened. Meanwhile, from the end of July - August 2007, the market fell, and so did the yen.

This pattern was broken at the end of 2008.  From November 2008 - January 2009 (see the highlighted area in the table above), the market rose and the yen fell; meanwhile, from January to March of this year, the market fell and the yen rose. Since March, the strong market rise has been accompanied by a drop in the yen.

Unfortunately, I cannot offer you a tidy answer as to why this relationship has changed.  Looking at volatility is of little use in answering this riddle. Indeed, you would expect that lower volatility would translate into a weaker yen: when the direction of the market is more certain, people are willing to enter yen carry trades, so they borrow yen and immediately sell them. This is what drives the yen down during periods of low volatility when people are more certain about placing such yen carry trades. The problem is that volatility has nothing to do with whether the market is rising or falling: you can have rising volatility in a rising or falling market, and falling volatility in a rising or falling market.

Perhaps one reason for the "new" pattern since the is political: embattled and embittered PM Aso wants to please his exporting constituency by keeping the yen weak? After all, and economics technicalities aside: the worse that his political fortunes since the start of this year, the weaker the yen has become...

So we are left with an unexplained result: since the start of 2009, a rising market has gone hand in hand with a weaker yen. All of which suggests that volatility has fallen strongly, thereby encouraging the placement of more carry trades. Not to mention that "kick in the Aso" factor that we just outlined.

If you believe in my "October crash" tale and, then the market probably will strengthen for the next few weeks (famous last words). That being the case, the pattern prediction is that the yen will fall, so go short the yen until the October crash. Once volatility rises, then go long the yen as of the October crash - until the market's downward momentum results in reduced volatility, at which point people will put on more carry trades and thus depress the yen again. This constitutes the ninth way to make money off the looming October crash. 

If you want me to explain why putting on carry trades depresses the yen, feel free to do so.