My Thoughts on the Yen and What to Expect Next

This past week has seen lots of action in the markets, and much more is to come.  Tech stocks continued their sharp decline, with Nvidia crashing all the way below 103 yesterday, having lost more than 27% of its value in less than six weeks.  Other stocks such as Advanced Micro Devices (AMD) have tumbled even further, as AMD has now lost over 40% of its value since March.  Meta has dropped by more than 18% in July alone, while Tesla has lost more than  20% of its value this month. 

It is time for a bounce, as tech stocks in general have become quite oversold in the short term.  The Nasdaq has dropped more than 10% from its peak, but it looks ready for a nice recovery.  Whether these bounces will be mere technical bounces in an emerging downtrend or the start of a final march to new highs is difficult to say.  The Fed will almost certainly be cutting rates in September, and market participants will want to seize on this as yet another excuse to buy stocks with abandon. 

As noted in my writeups, the equity market exploded higher in late 2023 when the Fed promised to start cutting rates in 2024.  The rally continued even as the Fed was forced to hold off due to its rosy inflation forecasts being extremely premature.  With stocks now near all-time highs, I suppose the fact that the Fed is finally going to lower interest rates is as good an excuse as any for people to yet again buy stocks.  One might wonder how many times people will continue to act on the same news, but we should never ascribe rationality to investment decisions by the public.  

For many years, I have been able to generate huge trading profits by relying on this remarkably simple principle.  The book written by Scottish author, Charles Mackay, “Extraordinary Popular Delusions and the Madness of Crowds,” addresses this type of irrationality in financial markets extremely well.  It was written in 1841, but its messages still hold true for today. For those of you who haven’t read the book, I strongly recommend it.  It debunks all sorts of things, ranging from alchemy and fortune-telling to economic bubbles.  It is his discussion about financial bubbles that caught my attention when I was shifting my career from academic teaching in comparative religion and Indian philosophy to finance.  We often fool ourselves by thinking that people have grown so much and evolved in their thinking and awareness, but I believe that a reader of this book will quickly conclude that the only things that have changed are the levels of our technology and the speed at which information now travels.  

Whether we are analyzing the South Sea Company bubble of 1711-1720, the Dutch tulip mania of the early seventeenth century, or the Dot-com bubble of 2000, the common factor of mass delusions is clearly evident.  By the way, in case you think our current futures markets are sophisticated, modern developments, think again.  The Japanese have traded futures on rice for hundreds of years, and the Dutch even had futures on tulip bulbs roughly four hundred years ago. 

Bubbles and market madness are quite simply the natural effect of the way our species is wired. I was lucky to realize this basic fact early on, and I was also lucky to realize that collective madness and hysteria can extend far longer than the capital of most speculators,  It was this simple insight that drove my decision to use limited-risk option strategies when I want to position myself for major reversals and the bursting of bubbles.  I accepted the fact that my analysis might be perfect, but the insanity of markets in a bubble could drive the pricing to levels that I couldn’t rationally anticipate.

At the same time, market bubbles always burst, and the bursting always leads to vicious and dramatic sell-offs.  This has happened for hundreds of years, and it will continue as long as people are making “independent” decisions about their investments.  The challenge for me has typically been how to time things, not so much to identify when the market has it “wrong” in the big picture.  Accordingly, my logical conclusion was that I should use option strategies to play for these giant reversals so that I could limit my downside risk while maintaining my predominant, long-term view.

This is actually a critical consideration, and it deserves some further attention.  At the same time the market can be remarkably wrong in the big picture, I also respect the markets and recognize that the current price is always “right.”  This means that while I might believe that a market is dramatically overbought or oversold, it doesn’t stop me from participating in a continuation of the move through trend-following strategies.  Therein lies the pragmatism of my basic trading philosophy.  How can these two seemingly inconsistent views coexist in my trading philosophy?

Let’s have a look at dollar yen as a prime example of how this plays out.  On the one hand, I have written extensively about my view that dollar yen’s rally up to and beyond 160.00 was dramatically overdone, and that it was inevitable that it would reverse and start a huge sell-off.  In fact, I have noted that depending on how things develop, there is a chance that the reversal in dollar yen will eventually cascade into a type of collapse.  I have written multiple times about using limited-risk, long-term option structures to play for this reversal, as it has been a view I so strongly hold.  On the other hand, I have also written about my active usage of shorter-term trend-following strategies to take advantage of market momentum to make money as the insanity continues. 

I don't bury my head in the sand and ignore current market behavior, even when it contradicts my forecasts over a long period. Instead, I take advantage of the basic principle that guides human behavior: crowds of people behave irrationally and take things to insane levels that they would never do if they were acting alone.  This fundamental human characteristic plays out in the markets just as it does in social and political settings.  It is a key component in my momentum-based trading strategy, as I recognize that once a market is trending, these trends will tend to continue.  

Naturally, I focus on different time periods for my trend-following strategies, as these plays are designed to capture moves that last for a few days or several weeks, rather than many months.  This allows me to stay in sync with a market on multiple time frames.  The combination of the strategies works well, but it requires a very disciplined approach.

Returning to the markets, as I expected, the Bank of Japan hiked interest rates early this morning, bringing their short-term rates to 25 basis points.  This is the second time since 2007 that they have raised rates, and short-term rates in Japan are now at their highest levels in sixteen years.  The Bank of Japan also announced that it is going to reduce its huge bond purchases as it continues to unwind its dramatic stimulus measures.  It is clear that the authorities in Japan finally recognize that the downside of yen weakness far exceeds the benefits.  

It is important to note that these moves by the Japanese central bank are taking place even as the economy has posted negative growth of 2.9% in the first quarter of this year.  Raising interest rates as the economy softens is actually a dramatic move that is more than symbolic.  Japan wants a stronger yen, and they have the power to achieve this goal.  My message to the Japanese authorities is that they should be careful what they wish for, as the ultimate level to which the yen strengthens might be quite a shock for them.  

Japan’s efforts to stimulate their stagnating economy have now continued for more than thirty years, and even pushing their inflation rate to 2.6% has been a dramatic struggle.  There is one thing that Japan can do to break out of its deflationary cycle, but it would be highly controversial.  I wrote about it once, and I hope it doesn’t happen, but the militarization of Japan would allow the country to grow through a huge expansion of fiscal expenditures.  

That is clearly a discussion for another day, but in the meantime, the yen is now trading at its strongest level since the middle of March 2024.  Finally, my stubborn conviction is playing out as forecasted, but remember, this is early in the move.  There is much, much more to come, but it won’t come in a straight line.  We will have periodic sharp corrections, so for those of you who want to get on board, it is best to wait for rallies to sell into.  They will absolutely come.  We have just dropped twelve yen in less than three weeks and volatility in yen options is much higher.  Therefore, I would not be anxious to simply buy yen options at the current volatility levels.   The volatility of shorter-dated options has doubled over the past few weeks, while the volatility of longer-dated options has increased by nearly 50%.  These are huge changes, and if anything, I would be a seller of short-dated options as part of a spread.  

For me, the overnight break below the November 2023 high of 151.90 was an important confirmation that the trend has reversed.  As you can see in the chart below, that level was also the high back in October of 2022, which we reversed from after rallying all the way from 102 yen per dollar.  This same level held twice during the recent shorter-term reversals from 161.90, so breaking below it is incredibly significant.  Even if we have a sharp technical bounce, the downside is now wide open.  

Remember, this is a move that will last for an exceptionally long time.  The Fed will be cutting rates, along with every other central bank – except for the Bank of Japan, which will be hiking again.  The unwinding of absolutely enormous, short yen positions is just starting.  The dollar’s decline will eventually be broad-based, but the yen will strengthen against all the major currencies.  

For example, as the yen has appreciated by twelve yen against the dollar, it has appreciated much more against the Australian dollar, Canadian dollar, and New Zealand dollar.  The Aussie dollar and New Zealand dollar have each weakened by roughly 5% against the US dollar as the yen has strengthened!  The Canadian dollar has weakened by about 3% during this period.  These are significant moves for currency pairs, but I expect these to be just the initial salvos.  

The Canadian dollar has finally reached my long-term target of 1.5035 against the euro, so in typical fashion it is time for a bit of a correction.  I suspect, however, that the euro/cad cross may finally break above the 1.500 level on a sustained basis and begin a march up to the 1.5900 level.  I have written about this currency pair sporadically only because it is so slow moving.  It is actually a great pair to trade if you are patient.

This brings me to the New Zealand dollar, the Kiwi, a long-time friend of mine that I have loved to trade in enormous size.  I am not 100% convinced about its next huge move, but my overwhelming bias is that it is getting ready for another crash.  Against the yen, the New Zealand dollar is almost certainly going to collapse.  The recent spike up to 99.02 yen per kiwi was the end of massive corrective rally, and the kiwi is now on its way to an initial target of 60.00, nearly a 40% drop!!  From there it will bounce, but its next target will be around 45, and potentially, it will even test 41.00 or 42.00 yen per kiwi.  If those levels break, then I would expect a final drop towards 31.00.  All told, that would be nearly a 70% drop in total. These are gigantic moves in the currency markets.  In fact, they are gigantic moves in any market.  These moves will take a long time to develop, but they are certainly worth playing for if you are patient and you have access to currency options.  

I will write more about the kiwi in the coming weeks, but this should give you an idea of what I am expecting.  

In the meanwhile, I wish you all the best of luck with your trading.

Andy Krieger