Spain suffers from weakness. But does the Japanese yen?

On this hodgepodge Friday I ask two questions. First ...

Is Spain Still the Proverbial Canary in the Coal Mine?

The big rally in the euro and periphery debt suggests the Cole Mine analogy for the single currency system may be obsolete. But it seems risk springs eternal for Spanish finance. If things don’t improve fast, Spain will likely be knocking on the ECB's door to gain access to the ESM stash.  


Today’s Wall Street Journal gave a good answer to a spin-off question: Besides the Spanish banks, and a handful of brave fund managers, who is buying all those Spanish sovereign bonds and driving yields lower and lower?

Spanish 10-year Benchmark Yield:

Answer: The Spanish Government’s Social Security Reserve Fund. 

According to The Wall Street Journal, approximately 90% of Spain’s Social Security Reserve Fund is tied up in Spanish government debt; that is up from about just 5% back in 2005. This helps explain why the European Central Bank is putting the risk of its own balance sheet in jeopardy with its unlimited bond buying plan. Spain’s Social Security Reserve Fund is running out of money and cannot continue to buy its own government’s debt. 

Of course the bet is growth will rebound in Spain this year and the ECB bond buying backstop will allow Spain to continue to borrow in financial markets. Plus, there has been a nice capital appreciation in the fund.  But the Journal adds, “But with unemployment now above 25% and fewer wage earners paying in [nasty set of demographics], the Social Security System is about €3 billion in deficit.”

So, maybe this will all end well. But it does point to the fact there are still large systemic risks embedded all across the Eurozone economy and why Angela Merkel continues to tell us the crisis is not over.  I guess we should believe her.

EUR/USD Reversing on a weekly basis ... hmmm ...

As for my second question of the day ...

Could the Japanese yen possibly be considered “weak” now?

Say what?  Now that the yen has started to move, currency war cheerleaders are now saying the Japanese yen is “weak.” It’s just nuts. Take a look at the chart below and then ask yourself if the yen looks “weak” to you (for those of you not spot fx savvy, a low value of USD/JPY means the yen is relatively strong against the US dollar). 

USD/JPY Weekly: When the latest US dollar bear market cycle began in late 1998-99, later depending on the currency pair, the yen was trading at around 145 to the dollar. The all-time low is 75 and change. The currency has jumped to 87. The long-term trend line comes in at around 110. 

If there is a sea change in Japanese finance on the way, and we believe there is, this currency is not cheap. It is highly unlikely Japan will be bullied any longer on this issue when analysts scream at the implicit intervention to “weaken” the currency. It shows both the prowess of Japanese export companies and strength of their beggar-thy-neighbor import duties (regulations, inspections, etc.) that the country has continued to produce trade surplus after surplus given the massive appreciation in their currency during this cycle. Looks like that game could be over as trade deficits have been the norm of late.

Is $-yen overbought now? Is it due for some type of correction? Likely yes! But by the time 2013 ends, we expect the yen will look a lot cheaper than it does now.   


Jack Cooks

P.S. If you feel like taking a quick trip to South Florida ... and you feel like building a foundation to trade foreign currencies ... I'm hosting a one-day Foreign Currency Workshop in Ft. Lauderdale on January 19th. Click here to get details and find additional information about this event.