It was little after midnight west coast time when the Bank of Japan dropped its bombshell. It said it would refrain from stimulating the economy further to offset the deflationary effects of the VAT tax increase from 5% to 8%, which took effect on April 1.
Within seconds, the Japanese yen rocketed and never looked back. The Nikkei stock average crashed. Traders were stunned by the BOJ?s ill-timed move, as many GDP forecasts for the current quarter hover around the negative -1% level.
I held back on covering my yen short, waiting for a pullback. It was not to be, and I had to stop out with a small loss. Given the heightened level of anxiety in the markets since last week, I don?t have to be told twice to unload a ?RISK ON? position.
I am in the fortunate position in that I can offset this loss with the major gains I made on my short S&P 500 (SPY) and Russell 2000 (IWM) positions. This is why the word ?Hedge? is in the name ?Mad Hedge Fund Trader.?
However, the central bank said it would stick with its current plan to increase the money supply by 60-70 trillion yen per year for the next two years. One of Japan?s confidence indicators fell to the lowest level since 2011. The government is said to be mulling over a further VAT tax hike to 10%. So don?t count on the central bank to stick to the hard line for very long.
Many think that this is just a speed bump on Japan?s road to economic recovery, and that more stimulus is on its way in July, once the magnitude of the current slowdown is indisputable. This could just be another case of central banks slow to adapt to reality, as they are often wont to do.
?Oh, how I despise the yen, let me count the ways.? I?m sure Shakespeare would have come up with a line of iambic pentameter similar to this if he were a foreign exchange trader. I firmly believe that a short position in the yen should be at the core of any hedged portfolio for the next decade.
To remind you why you hate the currency of the land of the rising sun, I?ll refresh your memory with this short list:
* With the world?s structurally weakest major economy, Japan is certain to be the last country to raise interest rates. Interest rate differentials are the greatest driver of foreign exchange rates.
* This is inciting big hedge funds to borrow yen and sell it to finance longs in every other corner of the financial markets.
* Japan has the world?s worst demographic outlook that assures its problems will only get worse. They?re not making enough Japanese any more.
* The sovereign debt crisis in Europe is prompting investors to scan the horizon for the next troubled country. With gross debt well over a nosebleed 240% of GDP, or 120% when you net out inter agency crossholdings, Japan is at the top of the list.
* The Japanese long bond market, with a yield of only 0.61%, is a disaster waiting to happen.
* You have two willing co-conspirators in this trade, the Ministry of Finance and the Bank of Japan, who will move Mount Fuji if they must to get the yen down and bail out the country?s beleaguered exporters.
When the big turn inevitably comes, we?re going to ?110, then ?120, then ?150. That works out to a price of $200 for the (YCS), which last traded at $65. But it might take a few years to get there.
If you think this is extreme, let me remind you that when I first went to Japan in the early seventies, the yen was trading at ?305, and had just been revalued from the Peace Treaty Dodge line rate of ?360. To me the ?83 I see on my screen today is unbelievable. That would then give you a neat 17-year double top.