We've had two volume reversals. The first was in mid Jan and the second, a week ago. These volume reversals were correlated with dollar weakness. In fact, when the dollar rises, the NIKKEI now doesn't fall much, but when the dolar falls, the NIKKEI jumps up. You can't get a better market state indication than upside/downside sensitivity to marginal demand/supply. That doesn't predict price, but it does tell you that if there is an exogenous event in the direction of the sensitivity bias, you get excellent price action in that direction. That's the best that can be done when trying to predict the state of random processes.
I stated earlier that the world's private banks and institutions are now preparing to test the mettle of the BOJ by buying the dollar. They will do this because they know the dealers in T paper are saturated and further sales from the BOJ to clear the dollar transactions would force the dealers to lower T prices significantly. The only countervailing strategy would be for the FED to buy the paper. Unfortunately, this has the effect of monetary base growth. The FED could clear the forex actions directly, but this would undermine the BOJ efforts. The BOJ has committed itself by the recent ill-advised move of massive intervention. They've shown their hand. They will have to do more dollar selling when the open market tries to take advantage of this situation.
There would be no lasting significance to persistent intervention unless the world had a large propensity to inflate. I assert that it has that propensity because worldwide and particularly in the US, there is a significant increase in strike activity. The degree of the propensity is seen both in the quantity of compensation demanded and the vociferousness of the demands. This response is the inevitable wealth effect and the FED knows they have to do something to shut them all up: like send out a message of unemployment through rising interest rates. That's what Greenspan had to fend off during the last FOMC meeting. Soon they will have to launch a pre-emptive strike by market absence or eventually they'll have to resort to stronger measures like market sales.
Rising rates in the US has the short term effect of downward pressure on the yen/dollar. Thus, the FED will delay as long as possible to raise rates and will fight the market by supplying enough funds at the margin to hold down the federal funds rate. At the G7 meeting the BOJ indirectly received assurances from foreign finance ministers that their central banks wouldn't participate in yen selling. So the BOJ by itself can hold off the private banks from initiating a run on the yen. I believe that the private banks will actually start buying the yen when they see that the BOJ is committed. While the FED is holding down the funds rate by opening the throttle, the strong yen/dollar will cause the NIKKEI to rise until the FED has to hit the brakes to prevent embedding structural inflation in the US. The yen and the NIKKEI will then correct.
I'm surprised that no one responded that if short rates rise in the US, short rates will be marked up in Japan through disintermediation and that would put the lid on a rise in the NIKKEI. Since I'm claiming the NIKKEI rise is not about expectations of rising corporate profits as much as it is a monetary knee jerk effect, then rising short rates in Japan will constrain a monetary driven response in the NIKKEI. This is a valid criticism, but it is a lagged muted response that just keeps the large institutions restrained. Japanese short rates don't rise much, but their monetary base does.Total demand for yen denominated assets (stocks) remains small but the currency and base effects make marginal demand large. This means that you get good upside action without volume. It is the same kind of action that has propelled the DOW higher this year: foreign holders of accumulated dollars intensely factoring them into a self-perpetuating vehicle of rational expectations of higher prices.
The BOJ is quite determined to defend the yen because now it's a matter of honor. It has gone beyond the rationalization of the needs of real economy. It is a matter of honor and pretentious power that Japan must fight world opinion. They have accumulated hubris as they accumulated the world's wealth. Now they feel justified in hitting back hard at an unreasonable world. The world wants Japan to inflate their economy into western indolence and mediocrity, but Japan absolutely refuses because they know their wealth came through hard work and discipline that is exalted by the free market system. The work ethic is deeply embedded in the Japanese psyche. They are on a holy mission to throw back the barbarians and glorify the samurai society of sacrifice. If you ever doubted the effectiveness of the Kamikaze, you'll learn to have respect if you're long the NIKKEI. |
