The Yen Is At A Crossroads

A week ago I suggested to my readers that it was time to take profits in gold at $3880. Since I issued my recommendation to exit our long position and take profits, gold has continued to rally, pushing up towards $4050 per ounce.   I have held this position for two years – since October of 2023,  when gold was trading around $1820 per ounce – so I am hardly bothered that gold is still pushing higher.  Eventually, I still believe gold has a lot of room to rally, but it is definitely stretched out and in need of a serious correction.  Once a market goes parabolic, it can carry on rallying to silly extremes, but frankly, I think that capturing a move that went well over 100% is enough. 

In fact, gold is dangerously overbought right now.  The technicals for gold right now are more overbought than silver was in 2011, when it spiked up to $49.83 per ounce before crashing to $11.64 – a 77% drop.  As I pointed out last week, silver is making a run at the all-time high, but it is also getting way overbought.  Gold, however, is even more overbought, and it is flashing red warning signs.  According to a variety of technical indicators that I watch, gold is now more overbought than the NASDAQ was in 2000.  In fact, I struggled to identify any other major markets that have posted overbought conditions more extreme than the current gold market, but I finally found one – Bitcoin in 2021.  The warning signals were flashing bright red in the spring of that year.  Several months later, Bitcoin plummeted from $68,958 all the way to $15,487  – a 77.5% drop.  Is it a coincidence that both collapses dropped by approximately the same amount? That is a discussion for a different time.  Would I consider a short position in gold through a limited-risk option strategy?  I am certainly tempted.  Am I forecasting a crash in gold?  Right now, I am simply warning you to be very, very careful.  By the way, one interesting thing to consider now that the major banks are touting gold rallying another 25% to $5,000 per ounce: Where were their forecasts when gold was trading under $2,000 per ounce?

I also suggested to my readers last week that “it is best to think of the yen’s reversal as an idea whose time may be coming. I am not fully on board the trade yet, but I am very, very interested in the idea.”  Historically, I have always been early when I play for major forex swings, so the yen’s sell-off since my last write-up is consistent with my long-term pattern of being early in forecasting big forex moves.  This is a perfect example of why I always like to scale into my position, a little bit at a time.  It is also a perfect example of why I have always liked to use limited-risk option strategies when I am playing for major forex moves. 

In fact, my favorite strategy for trade implementation is to allocate a budget for a major trend move.  The budget for long option strategies typically ranges from 1% of assets to 2% of assets once I am fully invested.  In the current situation I have invested less than 1/10 of 1% of the assets so far, so we have plenty of room to increase once we think it is time.  Remember, we are not just playing for one or two percent.  Typically, when we play for structural shifts, we like to play for moves of at least 8% to 12% (sometimes much more) so we are still very early with the yen idea.

I am now trying to decide how far this move in the yen can extend before the move is exhausted.  The recent sell-off in the yen was triggered by the surprising selection of Sanae Takaichi as the new LDP head in Japan.  After her selection, investors went wild buying Tokyo shares, with the Nikkei having rallied over 5% in just two trading days.  They have also gone wild putting on short yen carry positions. 

In light of the surprising political developments in Japan, I want to do a deeper dive into Takaichi’s policies. She held several key ministerial roles during Shinzo Abe's tenure as Prime Minister of Japan, reflecting her close alignment with his conservative agenda. Here's a breakdown of her positions in the Abe government:

• Minister for Internal Affairs and Communications
  • First term: September 2014 – August 2017
  • Second term: September 2019 – September 2020
  • Oversaw Japan’s telecommunications, local governance, and media regulation. Famously, she warned TV stations about license revocation if they aired content deemed politically biased.
• Minister of State for Okinawa and Northern Territories Affairs
• Minister of State for Science and Technology Policy
• Minister of State for Gender Equality and Social Affairs
• Minister of State for Food Safety
• Minister of State for Innovation

Political Alignment

Takaichi is widely considered a protégé of Shinzo Abe. She strongly supported his economic strategy, known as Abenomics, and shared his nationalist views, including a constitutional revision and a more assertive defense posture. Her economic policies reflect her deep alignment with Shinzo Abe’s legacy, but with a few distinct twists tailored to Japan’s current challenges. Here's a breakdown of her core approach:

Core Economic Philosophy: “Abenomics 2.0”

Takaichi is a staunch advocate of Abenomics, which combines:

• Loose monetary policy: She favors keeping interest rates low to stimulate borrowing and investment.
• Aggressive fiscal spending: She supports government-led investment in strategic sectors like energy, tech, and disaster resilience.
• Structural reform: Focused on boosting supply-side capacity and encouraging private-sector innovation.

Key Policy Pillars

1. High-Pressure Economy

• Uses fiscal and monetary tools to maintain excess demand, pushing companies to invest rather than hoard cash.
• Designed to stimulate wage growth.

2. Targeted Tax Relief

• Proposes refundable tax credits and higher basic income tax deductions to support working families and the middle class.
• Rejects broad consumption tax cuts, preferring more focused support measures.

3. Strategic Growth Investment

• Prioritizes sectors like:
  • Semiconductors, AI, quantum computing
  • Next-gen nuclear and fusion energy
  • Cybersecurity and disaster-proof infrastructure
  • Smart agriculture using satellite tech

4. Monetary Policy Coordination

• Supports Bank of Japan independence but expects accommodative policy to continue.
• May tolerate modest rate hikes if economic conditions are strong.

5. Security-Driven Economic Strategy

• Plans to establish a National Intelligence Bureau and enact counter-espionage laws to protect Japan’s economic infrastructure.
• Tightens control over foreign ownership of strategic assets.

Market Implications

• Her policies have driven a stock market rally and triggered a weaker yen, signaling investor expectations of stimulus and growth.
• Bond markets are cautious, fearing inflation and rising yields from looser fiscal discipline.

As you can see in the chart below, since the Nikkei’s bottom in April, the index has surged more than 55%.  The latest surge came about because of Takaichi’s reputation as being extremely pro-growth.  People in her close circle suggest that she may accept a 25-basis-point interest rate hike by January – but only if the economy shows strong growth and wage gains. She wants the BOJ to maintain a loose monetary policy stance while simultaneously pursuing aggressive fiscal stimulus to drive further economic expansion.  The problem with this logic is that these policies may have been warranted during the Abe regime due to the crushing deflationary cycle from which Japan was still trying to escape.   In my opinion, however, she is fighting the wrong fight for today’s conditions.  Japan is now saddled with too much debt and persistent inflation, making the fight against deflation –which was Abe’s main focus –  no longer the relevant war to wage.

Japan’s inflation is very problematic, and Japanese citizens are furious about it.  Moreover, Japan’s debt level is now the worst of any developed nation.  Most importantly, Japan has been recording trade deficits in 2021, and they have continued to record deficits every year since, including now in 2025.  This deficit is driven by high import costs and global economic pressures, and the weak yen is just making things worse.

A weaker currency is no longer stimulative for Japan.  Many years ago, Japan was able to capitalize on a weak yen to stimulate massive trade surpluses.  Today, however, the weak yen is a problem for Japan.  The yen’s undervaluation today stems from outdated assumptions -- namely, that Japan is still mired in deflation and that ultra-loose monetary policy is a given. But with inflation rising and trade deficits mounting, those assumptions are cracking.  Rising import prices are angering the population. The massive growth in tourism from China and Europe is a clear sign that the yen was too cheap when it was trading at 148.00.  The yen is now even cheaper, and it might get cheaper still.  Can we get to 155.00 or 156.00?  Sure.  Does that change my big picture view.  Not yet.

 What Could Trigger a Yen Revaluation?

Here are the most likely catalysts that could force markets to reassess the yen’s value:

1. Policy Pivot at the Bank of Japan

• A surprise rate hike or a shift toward tighter monetary policy — especially if framed as a response to persistent inflation — would jolt currency markets.
• Even a change in forward guidance could be enough.

2. Fiscal Retrenchment or Reform

• If Takaichi’s administration scales back aggressive spending or introduces credible debt-reduction measures, it could restore confidence in Japan’s macro stability.
• Markets would interpret this as a signal that Japan is serious about long-term sustainability.

3. Strong Wage Growth and Domestic Demand

• Sustained real wage increases and a rebound in household consumption suggest Japan’s economy is no longer reliant on stimulus.
• This would support a stronger yen by reducing the need for loose monetary policy.

4. Geopolitical or Trade Realignment

• A reduction in U.S. tariffs or a new trade agreement that boosts Japanese exports could narrow the trade deficit and lift the yen.
• Alternatively, global risk aversion (e.g., a financial crisis or geopolitical shock) could drive safe-haven flows into the yen.

5. Market Capitulation

• If speculative short positions on the yen become overcrowded, a short squeeze could trigger a rapid revaluation.
• This often happens when a few large players reverse course, forcing others to follow.
• Macro buying of yen from global investors who have invested huge sums of money into Japanese markets but sold yen to reduce the forex impact.  They could easily be induced to remove their short yen hedges with a bit of prompting from the authorities – or from a sudden yen surge higher in value.

Why the Mispricing Persists

• Many investors still view Japan through a 1990s lens -- deflation, aging demographics, and policy inertia.
• But Japan’s inflation is real, the trade balance has flipped, and the political appetite for stimulus is being tested.

The moment a major institution -- say, the BOJ or the Ministry of Finance -- signals that the old playbook no longer applies, the yen could snap back sharply.

Current Trader Positioning on the Yen

• Investment banks are backing off bullish yen bets after Sanae Takaichi’s surprise win as LDP leader. Her pro-stimulus stance has unnerved currency markets, pushing the yen past the symbolic 150-per-dollar level.
• Deutsche Bank and Goldman Sachs have closed long-yen positions, citing uncertainty around Japan’s policy direction and BOJ rate hike timing.
• Citi’s trading desk reports hedge funds are aggressively selling yen, with trading volumes tripling recent averages. However, banks and corporate buyers are quietly accumulating yen, suggesting some see value.
• Options markets show the least bullish sentiment on the yen since 2022. Risk reversals -- a gauge of sentiment -- have dropped sharply, though US dollar puts (bets on yen strength) still carry a premium

China is Japan’s largest trading partner, but the imbalance reflects Japan’s reliance on Chinese supply chains and its struggle to boost exports fast enough to offset rising import costs.  The chart below really tells us a lot!!  The yen’s value has crashed versus the yuan, so Japanese imports from China – their largest trading partner – have gotten more and more expensive.  The Ministry of Finance needs to take concrete steps to strengthen the yen.    On the other hand, Takaichi said last year that the Bank of Japan would be “stupid” to hike rates.   Frankly, she was way off base, and now that she is leading the nation, it is especially vital that she reassess the situation properly. 

As noted, I am not in a hurry to plow into a full long yen position.  Still, I think the yen is dramatically mispriced right now.  In 2022, before the Fed started hiking rates, dollar yen was trading around 110 yen/dollar.  After the Fed hiked rates aggressively, taking rates from .25% to 5.5%, dollar yen rocketed up to 161.80.  Since then, the Fed has cut rates by 150 basis points and the Bank of Japan has hiked rates by 50 basis points.  Moreover, the Fed is set to cut rates by another 75 basis points over the coming months, while the Bank of Japan will likely hike rates by at least another 25 basis points.  Dollar yen is definitely heading in the wrong direction right now.  I just don’t know how long it will take for the markets to adjust.

How overvalued is dollar yen right now? Probably by at least 10% to 12%. 

Can it stay overvalued for a long time?  Yes. 

Is the yen dramatically undervalued versus other currency pairs such as the euro and Canadian dollar?  Absolutely. 

It is situations like these that really get my attention.  The ECB has already cut rates by 1.85% as the Bank of Japan has been hiking, but these interest rate moves aren’t even reflected at all in the currency level right now.  The Bank of Canada hiked rates by 3.25%, and they have already dropped rates by 1.75%.  This is also not reflected in the forex markets.  For sure, the forex markets have my attention.  Interest rate differentials are not the only factor that drives currency rates, but they are generally a good guide with the major currency pairs. 

Of course, attitudes towards risk play a big role in the yen’s performance, and it is during risk-off scenarios that the yen will really shine. At that point, my estimates for yen undervaluation get much, much bigger.  With stocks at all-time highs, we don’t have much of a risk-off mentality right now, but even if I look at relative outperformance of stock markets in the U.S. and Japan, Japan is doing better than the U.S.   In any event, this sort of mispricing is exactly what got my attention in gold in late 2022, and over time I got fully invested. It is the same sort of analysis that goes into all of my major bets.  There will be a time when the yen becomes a fantastic buy.  Until then, I will wait for more signals that it is time to buy.    

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

Andy Krieger