Market Report: Currency Intervention Threatens Commodity Bull

Whose yen is it anyway? Strong yen, weak yen and why in the world does the oil market care? The Japanese yen and the dollar have been bit players in the massive run in oil. This year, as traders looked for trades to carry them away, one trade that was very bullish for oil was the dollar/yen carry trade.

Oil soared as investor sold dollars because of our negative interest and bought other currencies, even the yen, that were yielding a higher interest rate. Traders tried to lock in the difference between the rates. Aggressive traders would take the profit from that yield and try to use it as free money to make more aggressive trades. Some even bought oil! Imagine that. By buying oil, it was like doubling down because as the trade gained more popularity and because oil is priced in dollars as the dollar weakened, oil rallied even more. Other traders just took a piece of this trade by just selling the dollar outright or going long the yen or just buying things that would benefit by the weak dollar scenario like gold, silver, grains, copper, and, yes, even oil. Yet big changes in Japan and some mixed signals on the yen is causing some adjustment in this carry trade. It is also causing adjustments in the many cross currency/commodity spreads that in part explains why the oil and other commodities may seem to be less sensitive to movements in the dollar as of late.

This week the dollar soared against the yen when Japanese Finance Minister Hirohisa Fujii resigned late Wednesday for health reasons. His replacement Naoto Kan shook the carry traders by calling for a bit weaker yen and that many Japanese companies would prefer the dollar to rise to about Y95. Mr. Kan obviously believes that a weaker yen will help Japanese exports and may call for the printing of more yen or carry traders forbid currency intervention.

Reuters News reported that, "Indeed, Japanese authorities may be more inclined now to use the threat of currency intervention to warn the market over its dissatisfaction with yen levels." Reuters said that, "The Bank of Japan stepped closer to currency intervention on Nov. 27 than at any time in the last five years by checking exchange rates with commercial banks as the yen rallied to the 14-year high." Reuters reported, "hurdles for Japanese authorities to actually intervene in the foreign exchange market are very high. Intervention might send the wrong signal at a time when the Group of Seven is encouraging flexibility in foreign exchange rates, particularly in China. Japan would need the cooperation of the United States and Europe if it was to intervene, but that seems unlikely against this backdrop."

Yet is the desire for a weak yen the policy of Prime Minister Yukio Hatoyama? Who is speaking for the yen? Just who is the new Mr. Yen, or is the yen just speaking for itself. Did Japan's new Finance Minister Naoto Kan get too carried away? Prime Minister Yukio Hatoyama chided him by saying that the government shouldn't comment on foreign exchange. Kan shot back that, "While the prime minister's statement is right in principle, I, as the minister directly in charge of such matters must give sufficient consideration to expectations and hopes held by the business sector on the yen exchange rate." In other words, Japanese exporters want to sell more stuff and the strong yen is hurting them against the competition.

As the year wears on, the biggest threat to the commodity bull, other than rising interest rates and the reduction of global quantitative easing, is the rising threat of currency intervention. It is another way global central banks can manage inflation expectations without actually raising rates. The carry trade risk is that the relationship between a certain currency against the dollar. If the so called resource slack fails to dampen cost pressures and inflation expectations and global central banks are looking for a tool to knock the carry traders out of their comfort zone.

This trade has sent the dollar rising yet oil does not seem to care as they feel that despite the rhetoric the carry trade is still alive and well. They will keep the long commodity side and adjust the currency side. If you are not using the yen as your carry currency then you can wait out the yen dollar realignment and keep buying the commodity side especially if you believe the likelihood of a near term global intervention is imminent.

Today it is jobs, jobs and more jobs. A much better than expected jobs number could spike oil near $85 but then could reverse as the chances for a rate increase will rise. If it is much worse than expected, oil should fall hard on declining demand expectations but rebound on the lower rate outlook.