USDJPY Tactical Bullishness for 2w-1m Ahead?

Last week’s major theme clearly was with respect to the strong rebound after the initial Brexit shock. EM currencies of which have been unfairly smashed on the day for example, has strongly recovered. I think the overshot in price moves was one, and two, the terms of the UK’s exit were well, not to be negotiated overnight. An additional factor I believe  which suppressed post-event volatility was the relatively idiosyncratic nature of the actual macroeconomic shock, which will be dealt to the UK, and its most direct partners and not necessarily a systemic one at least on the short-term. Furthermore, the CB backstop, prior to the event on CB’s having a supportive mandate of cooperation to keep things functioning as best as possible (mentioning of providing USD funding on the day of Brexit etc), and most latest, ECB talk on abandoning the capital key, basically meaning that more bonds can be bought out of proportion from the respective Eurozone countries’ shareholding in the ECB. This led to European peripheral rates and fixed income rallying strongly. A key instrument we were watching last week was the 5y Italian CDS which jumped initially on Brexit, and concerns on the bailout fund to support ailing banks, however, post ECB news, the CDS essentially almost removed all previous widening, and the all-trusty VIX, is now back below 17; which in itself is quite impressive. Structurally, yes, things look quite frankly cookoo with negative yields, etc (China if you must), but the tape looks quite determined to stay risk on, and tactically, that seems to be the way to go for now. 

Fig 1: Italy CDS Trading Tighter at 150 bps

Fig 2: VIX Strongly Pushing Below 17

​Other signs of stabilization in the global picture I believe, is with regards  to the US ISM Manufacturing PMI of which has risen comfortably above the 50 threshold, now currently at 53. Commodity prices have also shown signs of bottoming (not only Oil, but softs as well, Iron Ore < which did not pop as people thought the speculative frenzy it was [or at least it got reflated]). 

Fig 3: US ISM Manufacturing PMI Stabilizing

​Bullish USDJPY: Whether you’re looking at EUR/antipodean crosses, or select EMFX, it seems that the recovery in risk-sensitive FX seems done – however some crosses such as the USDJPY proves to be one laggard worth looking into. Simple regressions done on the USDJPY vs Nikkei Vol, and the Nikkei, show that the USDJPY is trading relatively cheap, on both an absolute comparison, and returns comparison.

Absolute Nikkei vs USDJPY

Nikkei Vol vs USDJPY Absolute

Nikkei Vol Returns vs USDJPY Returns

​The year-to-date Yen appreciation has helped reverse the Yen’s severe undervaluation on a nominal REER basis, and looks to have reached a short term halt. Firstly, the BoJ seems to posture themselves as more trigger-ready (even if they won’t really pull the trigger) for intervention, which I think is a more credible threat given spot flirting with the 100 figure, and how far historically, the strength of the Yen move has been. A look at a 2-quarterly ROC shows that 10% appreciations in the Yen tends to quite an extreme as seen below. The BoJ has stated that intervention will be focused more towards the speed of the yen rise and not necessarily  the level. I think there’s some merit to this, especially when looking at the price action around the Brexit vote. The USDJPY’s test of 99.50 was met with a 2-big figure rally in the next 20 minutes.  

As we can see, if we use the EUR and the GBP as benchmarks of when the actual ‘bottom’ hit in FX, we can see this happened approximately an hour after the spike past 100 on the yen. BoJ possibly? Making matters even harder for the BoJ is the CPI which looks to face headwinds when looking at components of which previously were rising earlier in the year (food, industrial goods), which are currently looking to roll over. In addition to this, falling import prices for manufactured goods look to also pressure CPI to the downside. The two charts that depict this on the following page are courtesy of Credit Suisse and Daiwa.

We can see that risks are building on the side of BoJ action, and I think what makes the trade more probabilistically asymmetric for upside for the USDJPY, is the persistently extreme positioning of long yen positions as proxied by the COT. Sure, it’s just futures, but one can pretty much infer there’s a bunch of CTAs out there with net long JPY positions

​Being long spot would’ve been smart at 100.00, and isn’t as attractive now with most likely wider stops.
 
An attractive structure in options include a 2w (spot ref rate: 102.51) digicall for a 104.00 strike (priced at 22%), whilst a less attractive vanilla play via a 1m call spread 104 long, 106 short, costing 0.55% ,and max payout is 1.33%. 


​Somewhat Careful on USDIDR: Legit, the most favorite play this year, being short via 3m NDFs but have to be careful heading into 13,000 on spot, as Bank of Indonesia now officially state that they would intervene to ensure FX doesn’t’ appreciate too much on expected tax amnesty flows. Spot currently is at 13,100 and BI action in light of this is not something to expect to the likes of DM CB’s for obvious reasons of smaller FX reserves,  or even EM such as MXN back in February with Banxico. We’ll just most likely see spot stall at 13,000 as we did, and swing 200 ish to the upside. Coming ahead then, it would make more sense to look at FI / equities exposure. JKSE has blown highs above 5000, and it seems for a proper swing trade long, a wait would be warranted when some other worry around the world causes a generous enough dip to slug in some bullets.