Yen shorts: Why this ‘most important asset’ may be signaling a ‘fierce’ rally’

 ‘Smart money’ hasn’t been this bearish on the yen since 2012

For many Wall Street pros, the Japanese yen falls into the “most important asset” category, argues Dana Lyons of J. Lyons Fund Management. That’s because the yen has become the poster child of the so-called carry trade in which traders borrow at one country’s low rate and convert those funds in a locale offering the chance at a higher return.

Even to observers, the yen USDJPY, -0.13%  can be a useful barometer of risk appetite because when it’s falling it tells traders that rates will remain depressed in Japan. This signal, they believe, frees them up to use their borrowed money to take on riskier global assets. Conversely, when the yen is rising, anticipation of carry-trade unwinding spurs the selling of those assets.

“For the most part, as goes the yen over the past several years, so goes the carry trade—and risk-on assets,” Lyons said in a blog post. “The relationship between the yen and equities has been very tight

[on an inverse basis] over the past four years. When the yen has dropped, stocks have rallied— and vice versa—in a very consistent manner.”

 And now, a signal from the futures markets may be pointing to a significant decline for the Japanese currency, Lyons points out, and that could be great news for bulls with an appetite for risk.

Commercial hedgers, often referred to as the “smart money,” currently hold an “extreme” net short position in yen futures. In fact, they haven’t been this short in more than four years, right before the yen spiraled in 40% decline that lasted for three years—three great years for stock bulls.

Lyons offered many caveats, including the fact that the hefty short position isn’t really a catalyst on its own. Rather it “more accurately indicates the potential amount of fuel available in the event that the yen does indeed turn lower.”

But, he added, a trigger would be needed to initiate the drop.

Overall, Lyons says that while he remains in the camp that believes a new cyclical bear market has taken hold in the U.S. market, “fierce rallies” are still possible.

“While we have emphasized the fact that market dynamics are constantly in flux, we don’t yet see enough evidence to suggest that the carry trade relationship involving the yen is dead,” he said. “Thus, while we are not longer-term bulls, it is certainly possible that a futures-fueled yen decline could contribute to a solid intermediate-term rally in risk assets.”

 

Article: Market watch

 


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