By Vadim Pokhlebkin
If you've been watching the Japanese yen lately, you know that it has weakened significantly in the past two weeks. And yesterday (June 20), it dropped to its "weakest in more than four years versus the dollar and fell to near a record low against the euro." (Bloomberg)
The beneficiary of this weakness, in theory, has been the now famous carry trade, a popular way for big market players to take advantage of global inefficiencies. Carry trades came into being circa 1999, and they are not to be underestimated. Word on the street is that they are a big reason why global stocks have rallied over the past four years. And a sudden drop in their volume was rumored to be the reason for the global "mini-crash" on February 27.
Carry trade works like this: You borrow money from countries with a low interest rate and re-invest in countries where the rate is higher. A popular choice has been to borrow in Japan, where until late February the interest rate has been a measly 0.25%, and invest elsewhere, i.e. in New Zealand, whose securities currently yield over 7%.
But the trade works best under two conditions. One, there must be a sufficient interest rate differential between the borrowed and reinvested funds. And two, the currencies you borrow and re-invest must remain stable.
Both of these conditions are now under threat, say many analysts. The Bank of Japan plans to continue "gradually" raising rates, shrinking the interest rate gap between Japan and the rest of the world. And higher rates might strengthen the JPY, further discouraging carry traders. Some analysts expect the yen to strengthen to 118-115 JPY per USD in a matter of months. That's 6 to 9 figures below this week's USD/JPY high of 123.74. Big move.
Of course, everything you've just read is the fundamental reasoning. It assumes orderly, logical relationships between financial markets. However, as Elliott wave practitioners, we've seen a lot of evidence suggesting that forex markets don’t move based on logic alone – emotions play a huge role, too.
Perhaps that's why our present Elliott wave count for the USD/JPY is not nearly as bearish as the fundamentals may suggest. The latest weekly chart from our Currency Specialty Service suggests that the USD/JPY may be in a complex correction (likely a "triple zigzag") – and what's in store are higher, not lower prices:
Why do we believe that? Well, as our Chief Currency Specialty Service Analyst points out, despite all the recent gains, "it's been a long, long time since the USD/JPY has moved impulsively, in either direction. So I continue to view the rally from early 2005 as a correction [which is still] incomplete."