Japanese uncertainty presents opportunities

One of the trades of the moment seems to be long AUD/JPY.

Japan
Source: Bloomberg

As mentioned in a recent AUD/USD piece, low volatility seems to be helping the higher yielding currencies. However, this seems to be predominately benefiting AUD/JPY, which is also gaining momentum due to the diverging paths of the respective central banks.

AUD/JPY has moved aggressively from ¥91.76 on October 16 and now sits above ¥100 and could feasibly squeeze to test the top Bollinger band at ¥101.12. Moves back to the September swing high of ¥98.68 look like good buying opportunities, although I am sceptical it pulls back here in the short-term, given the low volatility seen in the markets.

It really is all happening in Japan at present. Local news flow has been speculating that Shinzo Abe has told party leaders to prepare for a possible snap election. This will presumably take place on December 21 after the cabinet is dissolved in the next two weeks.

This uncertainty could encourage a period of volatilitybut ultimately, Abe really needs to regain political momentum. With the opposition in all sorts of problems, now is the perfect time to strike. A national election would also be seen as an endorsement on Abenomics, so a new term for Abe would be seen as positive for markets and the Nikkei should continue on its bullish run.

The market is also fairly positive on speculation that the sales tax decision is likely to be pushed back until April 2017. You may recall that this had been scheduled for October 2015. With public debt levels at such high levels, such aggressive monetary policy rarely works, so reducing debt is absolutely essential. However, the other way to achieve debt sustainability is through increasing domestic monetary velocity and, in turn, boosting nominal GDP.  Nominal GDP needs to be above 5% in Japan for feasibly lower debt and this clearly isn’t happening, with next week’s Q3 likely to show growth running at a 2% annualised pace.

The market seems to be getting quite excited about the Government Pension Investment Fund (GPIF) starting to move money out of domestic bonds and into riskier assets and yesterday’s four basis point move higher in the 10-year Japanese government bond was the biggest move since 2012.

AUD/JPY is also benefiting from the strong demand for Australian assets from Japanese institutional flow, with recent data showing Japanese investors bought $1.7 billion of Aussie assets in September. That takes the total inflows since October 2013 to $21.73 billion.

Technically the pair is overbought, so the upside seems limited in the short-term. However, the path of least resistance still seems higher over the medium-term. If long, I would stay so and look to exit on a daily close below ¥98.68.

 

AUD/JPYClick to enlarge

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