Japanese Yen Hits Pandemic Low vs Dollar, Has a Bear Market Begun?

Before I get to the yen, a little background to put my forecast in context. My approach to the markets starts with a fundamental view. Then I test it against the markets and price charts. An example right now is stagflation, inflation or deflation? All three scenarios have different variables.

For inflation, defined here as a growing economy accompanied by rising prices, I expect a rising copper-gold ratio. Right now, I'm betting that copper-gold will break lower, hence I'm not expecting inflation. If I'm wrong, the chart will tell me soon enough.

Deflation and stagflation would both be in play if copper-gold breaks down. As the charts move through key support and resistance levels, it either confirms or rejects the hypothesis and changes the outlook.

As for the U.S. dollar, the bear market should be underway. It isn't playing out as expected though, at least it doesn't look like the past two bear markets. There isn't a lot of history to go on, but the prior two major U.S. dollar bear markets were immediate and severe. They saw the U.S. dollar decline almost uninterrupted for nearly 2 years before rebounding and settling into a slower pace of depreciation. (My read of the cycles is roughly 5 to 6 periods of bear, consolidation and bull, or a full cycle of about 18 years.) The current setup in the U.S. Dollar Index is short-term bullish, but the prior two bear markets saw barely any interruption. Maybe this is all a complex repeat of the 1998-2002 period. This scenario would see an extension of the U.S. dollar bull market in time, but maybe not price, into the start of the next bear market in equities (which in hindsight started earlier this year if there aren't new highs coming). If that's true, then the bear market is merely delayed.

Now on to the yen. The yen was in a bull market for decades after rebuilding from World War II. That trend may have ended following the massive Tohku earthquake and tsunami in 2011. Japan repatriated capital for rebuilding and pushed USDJPY down to a 75 handle. It has been in a weakening trend since then, one that is either cyclical or secular. For this post, I'll focus on the risk that it's a secular decline.

The ultra long-term forecast for the yen is collapse. All fiat currencies eventually hit zero. As John Mauldin put it about a decade ago, the yen is a bug in search of a windshield. Japan has been doing QE for 20 years. The Bank of Japan added stock purchases years ago. Almost every major factor that justifies a dollar collapse is worse for the yen.

The long-term forecast is a cyclical bear market. Historically, the yen has been like USD on steroids because of the carry trade. As reserve currency, the US dollar inflates along with credit during boom times and deflates during recessions. The dollar depreciates during the booms and appreciates during the busts. The yen became a turbocharged version of this cycle because investors and speculators used the currency for the "carry trade." They borrowed in zero-percent yield yen and bought all manner of assets from high-yielding New Zealand dollars to stocks and commodities. If the economy is recovering or entering an inflationary cycle, the yen should move lower. Since Japan is still an energy importer and U.S. energy production has increased in the past decade, the yen might be weaker versus the dollar than it was during the 2000s. Within a stable range, a rising USDJPY would be a positive sign that the global economy is recovering. Below we'll see why the charts suggest it won't be stable.

EURJPY expresses this inflation/deflation cycle. EURJPY gained 90 percent from low to high in the 2000s. This pattern is heading for a breakout of trend in either direction, but my expectation is higher.

Here is USDJPY. In the short-term, USDJPY just tagged its March 2020 pandemic high. A continuation would be bullish for USDJPY. Zooming out, USDJPY is about 11 percent from completing a large inverse head-and-shoulders pattern at 125. Moreover, the base started in April 2019 that goes through the March 2020 top of 112.23 and was hit on Friday, has a measured target of near 125. In other words, the chart says a move higher is going to test major resistance.

The next chart shows the measured move if that two-decade pattern completes: USDJPY 175. Zoom out further back to the 1970s and it looks like a monster base forming in USDJPY. The trendline resistance going back to 1986 is at 118 right now. That's going to break if 125 is coming. Beyond that, there's another huge base out to the 165 area, or the bottom of the Plaza Accord move. That was a coordinated devluation of the U.S. dollar by the major world economies at the time. If that completes, the next target area would be USDJPY 265.

Some other crosses that could help put a yen move in context. For commodities, a bull market is sometimes defined as a move that's visible in all currencies. If currencies that are depreciating versus USD make new highs versus JPY, that will indicate JPY is in a major bear market.

Another is CNY. Thanks to state control, the yuan has lower volatility and tracks with the U.S. dollar. The chart of CNYJPY looks similar to USDJPY with a base forming and heading for a test of resistance. The lower chart shows USDCNY. If I'm right that USDCNY has bottomed and CNYJPY is heading for a breakout, that translates into a bigger gain for USDJPY.

The yen is 13.6 percent of the U.S. Dollar Index. It is an export economy that competes with China, South Korea and the EU. Similar to all those nations, it is an importer of energy. A big question for a yen meltdown scenario is will it be an internal collapse caused by domestic factors or will it be the first of many, or coincident with many similar depreciations? As we get closer to USDJPY 125, concern about the yen will start increasing. More investors will start watching this chart. If that coincides with a rallying U.S. Dollar Index and strength against the euro, volatility will also be rising as fear of a major breakout comes creeping into world markets.

Conclusion

The Bank of Japan implemented a zero interest rate policy (ZIRP) in 1999. in March 2001 it started quantitative easing, with early stops and reversals followed by QE-to-infinity. It went to a negative interest rate (NIRP) in 2016. If these policies are as wrong and destructive as many critics (myself included) of the Federal Reserve charge, then Japan is going to have a far worse fallout when these failures are revealed. If the yen is in worse shape that the dollar, that is expressed as a "stronger" dollar, rising USDJPY.

Beyond a short-term forecast, the context of a rising USDJPY will matter. If there's a stable, inflationary global growth cycle, then it probably peaks long before it destabilizes world markets or at least it takes years to reach that point. I would expect USDJPY would clear 125, but fall short of 165 in this scenario. If there's stagflation, that's a break with 40-years of global economic history. Energy and food importing Japan would be in trouble. If the U.S. stock market goes into a bear market and USDJPY falls like before, then maybe the global economy is still trapped in post-2008 conditions. If instead the DXY rises in a stock bear market, but the yen keeps falling, that is a break with 20-years of history. The major trendlines shown above can be interpreted as the dividing line between past and future. As long as they're intact, we can look to the past for guidance. If they break, the future has arrived and with it will come major changes in global economic arrangements.