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I wish I had a dollar, or maybe a euro, for every time an
analyst equated the current subprime mortgage crisis to
the Asian financial crisis, and every time the housing
bubble was likened to the tech bubble.
With the "R" word threatening in 2008, analysts and
economists find themselves turning to earlier events for
guidance.
I plead guilty to making these very same comparisons, and
I'm going to do it again today. Specifically, I want to
tell you why volatility is returning to the markets and
why that's great news for the Japanese yen ...
History Is Repeating Itself, So Listen Up!
Recession reared its ugly head in 1987 and the pain lasted
until 1990. You know what happened in the interim? The
currency markets went crazy!
Things calmed down until 1998, when the Asian Financial
Crisis set in. The result: You guessed it ... a spike in
volatility among the world's major currencies (as measured
by the JPMorgan G7 volatility index).
Even though volatility quickly came down from that peak,
it remained relatively high as the years following the
crisis wore on.
Finally, around the beginning of the new century, things
were calming down. Until, that is, the overly-inflated
technology bubble burst, sending the economy into another
recession.
End result: Foreign exchange volatility surged yet again!
It wasn't until after investors accepted the failure of
many dotcoms that volatility finally began to wane. As the
recession faded, so did unpredictability in the currency
markets.
I'm sure you see my point: Volatility in the currency
markets follows a fairly predictable pattern. When crisis
strikes or recession sets in, the currency markets turn
erratic.
And right now, there are plenty of reasons for the cycle
to start all over again ...
Housing Bubble Bursts, Subprime Loans Implode, Recession Coming!
One year ago, the JPMorgan G7 volatility index was at a
record low. Sure, the housing bubble had already begun
deflating, but the subprime meltdown had yet to wreak
havoc on the financial markets and recession was a very
distant threat.
Conditions were calm and predictable — borrowing rates
were low and global markets were rising as far as the eye
could see.
It was an ideal environment for the carry trade, borrowing
on the cheap and investing in high-yield plays.
Traders didn't have to do very much to make serious
profits. They just borrowed cheap money from places like
Japan, where interest rates were low and exchange rates
were fairly stable.
Then, they plowed it into pretty much anything else that
struck their fancy. It was a golden ticket to easy
profits.
But Now, Things Have Gotten Risky Again!
In December, volatility spiked to levels not seen in more
than nine years.
At the same time, the Japanese yen has experienced a
substantial rally versus most other major currencies.
Reason: Volatility is anathema to the carry trade. And the
yen is a traditional safe haven for traders.
Traders can no longer sit back and rake in returns from
yield differentials or the difference in various interest
rates.
Prices are moving all over the place. The carry trade is
no longer a one-way trip down easy street. In order to be
successful, traders need to switch their bets.
So, they're doing the same thing they did during recession
in the late 80s ... the Asian Financial Crisis in the late
90s ... and the dotcom bubble eight years ago ...
Traders are turning to the Japanese yen to save their
bacon!
Yen Is Poised to Rally Further as Risk Rises
Think of it this way: If you borrowed cheap money to buy
something else, but that something else started falling in
price you'd want to cut your losses and pay off the loans,
right?
Well, that's precisely what's happening now. Investors and
institutions inside and outside of Japan are
pulling away from risk and repaying their yen loans.
Plus, a growing number of traders are also buying up the
yen for pure speculative purposes because they know that
the yen will rally against the U.S. dollar and
higher-yielding currencies.
Historically, this directional shift is the way market
bottoms are often made. And while there are no sure bets,
I sure think the Japanese yen has plenty of upside ahead
of it.
Best wishes,
Jack |
