The time to short the yen is now – but the dollar isn’t the best way to a big profit

Japan’s newly elected president, Shinzo Abe, has signaled his intention to do whatever he can to devalue the Japanese yen in order to provide a boost to the nation’s ailing economy. This article looks at how traders and investors can profit from it.

The time to short the yen is now

As was widely expected, yesterday saw the return to power of Japan’s Liberal Democratic Party (LDP) led by Shinzo Abe. The LDP, which ruled the country almost continuously between 1955 and 2009, won 294 seats out of a total of 480 seats in the lower house of parliament. Together with its coalition partner, the new Komei party, the LDP has 325 seats, enough to give them a so-called supermajority, i.e., two-thirds of the seats in the lower house of parliament – enough for it to block decisions made by the upper house.

Shinzo Abe has said that his top priority will be the economy, in particular, combating the deflation that has plagued the world’s third-largest economy for over two decades. In recent weeks Abe has been quoted as saying that he is in favour of “unlimited” monetary easing by the Bank of Japan (BoJ). It is also expected that he will nominate a new governor to replace Masaaki Shirakawa whose term as head of the BoJ ends in April.

Having formed his cabinet next week, it is thought that Shinzo Abe will bring considerable pressure to bear on the BoJ to print fresh yen and inject them into the economy. The objective will be to dilute and therefore devalue the yen, thus triggering inflation.

Abe reiterated yesterday that he wants the BoJ to increase its inflation target from 1% to 2%, a move that we may see as soon as 20 December.

Bruce Kasman, chief economist at JPMorgan Chase & Co., described the LDP party’s election win as “one of the most important monetary policy events for 2013”. Last week Kasman’s colleague Masamichi Adachi in Tokyo said that the BoJ may adopt a “new style of open-ended asset purchases” as soon as this week.

A 15 year chart of the Japanese yen (Click on the chart for a larger version)

Chart courtesy of

Thanks to the unwinding of the yen carry trade, the Japanese currency began a long uptrend in 2007. In late 2011 however, that rise came to an end and following a significant bounce that lasted much of this year, the yen now looks to be in a long-term decline.

How to profit from the deliberate devaluation of the Japanese yen

With so many of the world’s central banks engaged in deliberate currency devaluation it is increasingly difficult to find a strong currency to short the yen against. In particular the US Federal Reserve’s 12 September announcement of open-ended QE makes the US dollar a less than ideal candidate, since both currencies will be declining simultaneously.

Perhaps a better option would be to be short the yen against one of the commodity currencies such as the Canadian dollar or the Australian dollar. That’s because the Chinese economy appears to have made a cyclical bottom, and renewed demand for base metals and other commodities should benefit both Canada and Australia.

According to some sources, the sale of commodities such as iron ore and coal makes up nearly 55% of Australia’s annual revenues, and the country’s biggest client is China. As Ambrose Evans-Pritchard pointed out in a recent article entitled The world’s commodity supercycle is far from dead, in 2011 China’s share of total world demand for commodities was: “soya (27%) cotton (38%), aluminium (40%) iron ore (40%), coal (42%), zinc (42%), lead (43%), copper (43%), and lean-hogs (50%)”.

As a result of deliberate policies aimed at cooling its property price boom, the Chinese economy has slowed. However it is still growing at over 7% and as Paul Bloxham, Chief Economist at HSBC pointed out recently, “real commodity prices at well above their late 20th century levels are expected to continue to support Australia’s growth prospects”.

Evans-Pritchard also notes that the Reserve Bank of Australia argues that the construction boom in China “will not peak in absolute terms for another five years as 20 million rural migrants pour into the cities each year. The pace will not slow much until the urbanisation rate reaches 70% in 2030”.

The bottom line

There can be little doubt that the Japanese yen is headed lower, the difficulty for traders and investors however, is finding a way to capitalize on it. As mentioned in the 13 July article Profit from the decline of the Japanese yen as the unwinding of the yen carry trade comes to an end:

Longer-term investors should, “consider buying a selection of Japanese exporters that stand to benefit from a lower yen… These companies are likely to see greater demand for their products thanks to the greater relative purchasing power of foreign buyers. In fact, some of these companies are already beginning to raise their profit forecasts.”

The problem however is that Japan’s traditional export customers, i.e. the US and Europe, have also now adopted ultra-loose, open-ended monetary policies aimed at devaluing their currencies. As a result the best bet for capitalising on a weakening yen looks to be shorting it against the Australian dollar, perhaps via a spread bet.

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