Excuse me, sir, this Yen is a little overdone!

     Can you believe it? it's been almost ten years since we welcomed the new millennium. Ah, the year 2000.... the year that brought us such great excitement of a bright and promising future was also the year that brought us the wrath of the burst of the dot com bubble. It was also the year that brought us what is possibly the greatest carry trade ever - the Yen carry trade. With interest rates effectively at zero, the Yen became the vehicle of choice for funding carry trades against other higher yielding currencies such as the Aussie, Kiwi, and the Euro. It was a smooth sail for carry traders that lasted the good part of a decade - a time of (what then seemed to be) risk free, free money. Investors raked it in hand over fist, collecting interest payments while their higher yielding assets kept appreciating relentlessly. As the world economy recovered from the dot com bust, sending interest rates higher everywhere but Japan, the carry trade became self-propelled. Even a rising Japanese equities market accompanied by moderate rate hikes as of July of 2006 did almost nothing to cool the red-hot carry trade.

Then came Bear Sterns, then Lehman, then....a series of global rate cuts as legions of talking heads on CNBC declared the end of the world was finally here. The unwinding of the carry trade was fast and furious. Within four months(!!!), the Yen has pared a decade's worth of losses as traders rushed to cover their short positions while many others flocked to the Yen, seeking its relative safety in uncertain times. Even as the carry trade seemed completely unwound, the Yen maintained its safe haven status and readily bounced on any sign of weakness in the global recovery which started on March 9th 2009.

A New Government Steps In

Following an August election, a new government, led by the Democratic Party of Japan, took power in September of 2009. With less than one month in office, the newly appointed finance minister, Mr. Fujii, already managed to cause waves in the foreign exchange markets by talking up a strong Yen. We may never know exactly why did Mr. Fujii made such dubious comments in his first days in office. But the result was obvious, and an already upward moving Yen was pushed even higher.

In November of 2009, the global recovery (or bear rally - you decide) showed signs of fatigue and concerns over the sustainability of the recovery started to arise. On November 15th, Japan's preliminary GDP numbers came in  much better then expected. The stronger economic reading for Japan, coupled with a global recovery in question, sent the the Yen on a two week dash that culminated over the Thanksgiving holiday with news of Dubai's impending credit crisis sending tremors throughout the global markets. Even as the dollar advanced against most other currencies, it lost ground to the Yen, reaching low levels not seen in years.

It did not take long for the Japanese government to change its tune as a strong Yen put too much pressure on a very fragile and very export dependent economy. Japanese rhetoric reversed and officials were quick to point out that Yen strength came on the back of a weak dollar without any fundamental basis. Of course, with a struggling economy, aging population, astronomical debt, zero interest rates as far as the eye can see, and loose monetary policy, what fundamental reason is there for the Yen to go higher?

Friday's NFP report shed some light on what could be fueling the Yen's relentless rise - flight to safety. The NFP report, which came in much better than expected sent the Yen on a sharp move down against the USD and other major currencies. The NFP numbers and easing concerns about Dubai (which proved to be short lived) gave the market a glimmer of hope and the Yen's reaction is indicative of its role as a safe haven. Since Friday, dark clouds have gathered once again in the form of credit downgrade in Greece, gloomy outlook in Spain, and lingering concerns regarding Dubai. The result? a stronger Yen.

Waiting for Intervention

Talks about Japanese intervention have surfaced in the media over the last couple of weeks and as of today, it seems a somewhat likely scenario. This is a major shift in paradigm for Mr. Fujii from his remarks back in September. Of course, intervention is an extreme measure and is not guaranteed to work - so whether or not the BoJ will intervene is anyone's guess. What is more likely to happen is for Yen pair to base in the short term, creating an invisible fence to ward of Yen bulls. This line in the sand may provide excellent buying opportunities in some Yen pairs, esp. against strong currencies like the Canadian dollar or the Aussie.

Can You Spare a Buck?

It's been a tough ride for the USD since March, not so much of a roller-coaster as a Double Black Diamond slope. The USD peaked earlier this year due to extreme levels of fear and uncertainty in the global financial markets. The end of the world seemed like a done deal and the all-mighty Dollar was everyone's bet (mostly in the form of US treasuries), in what was dubbed the "risk aversion" trade. Since March, however, the  USD declined, in a twisted way, on every piece of good news that would normally make a currency stronger. And thus came about the "risk trade". With historically low interest rates and generous QE, the dollar was left alone and defenseless, surrounded by some very scary bears with their claws sharpened and ready for the attack.

Vociferous pros eulogize the greenback daily on various financial media outlets and foreign governments diversify their reserve holdings with gold (India) and Canadian Dollar (Russia). Indeed, the currency has not been able to stick its head above the 10 EMA (weekly, see below) since May. However, even among the big bears out there, there seems to be a growing consensus that a bear rally is in the cards and Friday's market action could have signaled the opening shot.

Fundamental, meet Technical

Fundamentally speaking, there are two scenarios in which the USD slide can reverse, even if only for a relatively short period, and they are (1) deterioration of financial markets and return to risk aversion or (2) interest rate hike by the Fed. Technically speaking, the DXY (aka dollar index) is entering a support level (see weekly chart below) in the 74.50 to 71.50 range.
It always astonishes me when trend-shifting fundamental news "magically" coincide with major technical levels. Over the past two weeks, the DXY came close to a major weekly support level and, wouldn't you know, we got a taste of both bullish scenarios for the USD.
The first came in the form of financial turmoil in Dubai (risk aversion). The second came a week later in the form of much better than expected NFP numbers, causing markets to expect rate hikes earlier than previously predicted.
Of the two events, Friday's NFP report was much more significant because while the reaction to Dubai World's woes was according to expectations, the reaction to the NFP numbers marked the first time in months when a good economic reading led to a stronger dollar signaling a possible break from the inverse relationship between the dollar and the state of the economy (and the equities marker).

Obviously, it is too early to to tell if the dollar rally will fizzle or sizzle and the dollar bulls should hold off on the champagne - at least until New Year's.