Fishing for a Bottom to Dollar-Yen

Since the initial spike higher when the BOJ provided some operational tweaks to its asset purchase program on December 18, the dollar has fallen 5.6% against the yen through Tuesday's low near JPY116.70.  We had warned that the break of JPY120 would spur a move to JPY118, and the move below JPY118 targeted the August low near JPY116.20.While the euro often carves out a bottom, the dollar's lows against the yen are frequently characterized by spikes.  That was the case, for example in the middle of October and late-August and the low (~JPY115.60) in December 2014.  Such a spike may have been recorded yesterday.    A close above JPY118 would boost confidence that a low is in place. However, much technical damage has been inflicted.  It may take a move back through the JPY118.70-JPY119.15 band to be anything significant. The yen's sensitivity to global financial market disturbances and the fact that equity markets remain on edge despite today's better showing means that many short and medium term participants may not want to be exposed to a short yen until they have greater confidence that China is stabilizing.    Although speculators, as of a week ago, had the first net long yen position in the futures market in three years, we are still skeptical that safe haven is really the best way to describe or explain the yen's strength.  Instead, we suspect that disorderly markets encourage Japanese investors to keep more of their savings at home, and prompts an unwind of short yen long risk asset positions. Yesterday Japan reported a November current account surplus that was more than a quarter larger than expected.  The current account surplus was not driven by the trade balance.  In fact on a balance of payments basis, the trade deficit was 70% larger than expected at JPY271.bln. Instead, the driver of the JPY1.143 trillion current account surplus was the investment income surplus (JPY1.54 trillion) which is the largest ever recorded in November.  This is a function of income generated Japanese companies foreign direct investment (royalties, licensing fees, etc.) and coupons and dividends from overseas portfolio investment. Japan also recorded an unusual surplus on service trade.  The JPY61.5 bln service surplus contrasts with a 12-month average deficit of JPY145.8 bln deficit.   This is reflecting the surge in tourism, which is treated as an export of services in balance of payment calculations.  The number of tourists visiting Japan last year increased by 50% over 2014. Both the investment income and the tourism may have been inflated in part by the decline in the yen.  The weaker yen makes the foreign-derived coupons and dividends more valuable in yen.  The decline in the may also make Japan are a more attractive vacation destination.    The Abe government has also taken measures to encourage tourism on the margin.  These include expanding the range of goods tax-free for foreign visitors in October 2014 (to include electronics, for example).  The government has also expedited the sales tax refund process for foreign visitors. Some economists forecasting the yen put emphasis on its current account surplus.  We do not show a robust relationship.  Moreover, the weakness of the yen boosted the yen value of the investment income earned overseas not by boosting export volumes.    It is more of an accounting and translation issue than a reason to become bullish on the yen. In addition to equities stabilizing, another development that would lend support to the dollar is yield differentials.    At the end of last year, the US 10-year premium over Japan rose to 203 bp, which was the most since September 2014.    Yesterday, near 185 bp, it was smallest in a month.  Today it is bouncing back and is poking through 193 bp. Yesterday, as oil prices slipped through $30 a barrel, US 10-year yield slipped below 2.10% for the first time since late-October.  The March note futures posted a bullish outside up day.  However, there has been no follow through buying, as the bounce in oil, commodities and equities have stolen the bid.    The yield is poking through 2.13%.   Japan's 10-year yield slipped to a marginal new record low below 20 bp.