Are the Yen’s Gains Sustainable?

07/15/2010 12:01 am EST

Focus: FOREX

Neither a political shakeup nor weak economic fundamentals can stop the surging Japanese yen as the currency has gained nearly 1000 pips since recent lows were made back in early May. This past weekend, the ruling Democratic Party of Japan (DPJ) and its coalition parties failed to gain the 56 seats needed to continue to control of the Upper House, putting into jeopardy any attempts from the ruling government to pass legislation. The election defeats were an especially big blow to Prime Minister Naoto Kan and his attempts to raise the county’s consumption tax from the current 5% in order to help pay down the country’s massive deficit.

Normally traders and investors would move away from a country’s currency during times of political uncertainty, however, after a minor selloff last week, the yen has once again found some support—especially versus the euro currency. A stronger yen is the last thing Japanese businesses want to see, as its economy is highly export-driven, and a stronger yen hurts the competitive advantage of the nation’s businesses. The recent loosening of the yuan “peg” from the US dollar by China seems to have triggered buying in other Asian currencies, such as the Korean won and the Japanese yen. The popularity of the yen as the “funding ” currency for so called “carry trades” might be the biggest reason behind the yen’s strength, especially as traders cover these short yen positions in a move to liquidity given the recent volatility seen in the global equity and commodity markets. However, once the majority of the speculative short positions have been bought back in, It would not be a surprise to see the Bank of Japan (BOJ) attempt to jawbone the yen lower with talk of potential interbank intervention once the speculative short-covering catalyst is out of the picture.

Trading Ideas

Here is the current dilemma for yen futures traders: The short-term technical trend is bullish for the yen, but the long-term fundamentals are favoring a weaker yen. Given this scenario, a trader may choose to explore positions using options on yen futures that could benefit from the above scenario. An example of such a trade would be the purchase of a put calendar spread, such as selling a September yen 1.10 put and buying a December yen 1.10 put. With September yen futures trading at 1.1300 as of this writing, the December/September calendar could be purchased for about 1.31 points, or $1,637.50 per spread, not including commissions. A trader purchasing this spread hopes that the shorter-term option expires worthless and the credit received will help offset some of the premium paid for the longer-term option.

Technicals

Looking at the daily continuation chart for Japanese yen futures, we notice prices holding well above both the 20- and 200-day moving averages. This confirms that, based on chart analysis, bulls are currently in control of the market. The yen market is a good example of where it is important to not just rely on fundamental factors when making trading decisions! The 14-day RSI is still positive, with a current reading of 61.43. The recent low of 1.1225 made on July 12 looks to be support for front-month September yen futures, with resistance found at the recent high of 1.1502.

By Mike Zarembski, senior commodity analyst, OptionsXpress.com

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