While the Japanese Yen fell to a fresh 4 year low against the New Zealand dollar and 19th month low against the British pound and Canadian dollar during the Tokyo session, the currency is now higher across the board as traders take profits ahead of the weekend. By now, everyone should know that Shinzo Abe's publicly vocal attack on the Bank of Japan is the main reason why the Yen has sold off aggressively. The LDP leader has demanded the Bank of Japan adopt a higher 2% inflation target and to print money continuously to achieve this goal. With annualized inflation currently at -0.4%, this demand basically translates into an open ended commitment to easy monetary policy. If the BoJ fails to comply, Abe has also threatened to strip away their independence. These outrageous claims have made Abe extremely power with a country that has grown increasingly frustrated with persistent deflation and 20 years of zero growth.
Beware of a U-Turn in USD/JPY
Yet considering that most investors expect Shinzo Abe to win, there's a strong risk of a buy the rumor, sell the news type of reaction in USD/JPY. In other words, rather than extending lower, the Yen could actually rally if Abe wins. According to the CFTC's Commitment of Traders report, short Yen or long USD/JPY positions were at their highest level since July 2007. While we have seen these positions reach even greater extremes in 2006, whenever we hit extreme levels over the past 2 years as shown in the chart below (white line = IMM positioning, gold line = USD/JPY), USD/JPY topped out shortly thereafter. A perfect fundamental catalyst for a U-Turn in USD/JPY would be back peddling by Shinzo Abe. He may have ran on a campaign of greater pressure on the BoJ, but it wouldn't be the first time that a politician has backtracked on campaign promises. Also at the beginning of this month, Abe hinted that he could reduce pressure on the BoJ once he takes office. In a debate with Party Leaders, he said, "If I become prime minister, I will not comment on specific monetary policy measures, which should be decided by the Bank of Japan, I am commenting on specific measures because I am in opposition." BoJ Governor Shirakawa's term also ends his 5 year term in April of next year at which point Abe will have an opportunity to nominate a candidate who is more willing to ease. In other words, with only 4 months left in Shirakawa's term, Abe may choose to wait and not force a change in BoJ law that would risk infuriating business leaders if he can put in place a BoJ Governor that supports his view. Abe cannot "appoint" a BoJ Governor but he can nominate a candidate that needs to be approved by the Lower and Upper Houses. While a U-Turn in USD/JPY could flush out many short Yen traders, leading to a sharp reversal in the currency pair, when the dust settles, monetary policy still needs to become easier because growth remains very weak.