Spread trading: contango or backwardation?
29 January 2023
Spread trading with… fantasy!
20 February 2023
Two days ago I received an e-mail from Clément with his analysis of Usd-Jpy. Before I make a few thoughts, I will quote the analysis exactly as it came to me, without changing a comma.
JPY: The inflation in Japan is at 4%, the highest level since 1981 (twice the objective of the BOJ), this inflation is mostly due to import prices. I think that inflation will continue to increase in Japan for many reasons, for example, because of the reopening of China; China represents 21% of its exports to Japan and 22% of its imports. Another example, the savings of the Japanese are at very high levels, and consumer confidence grows month by month, the loans in Japan grow month by month, and the earnings of the Japanese grow, the unemployment in Japan is very low...
The interest rates in Japan are at -0.1% since 2016, to expand the economy (politic Abenomics). The actual president of the central bank of Japan, Kuroda, has maintained an accommodative monetary policy, but I think that this inflation will continue to grow and that the BOJ will have to change its monetary policy, in addition, in a few weeks the president of the central bank of Japan will change. The speculators are expecting and speculating on an interest rate increase because the return on the japan debt at 10Y is past one day of 0,2 at 0.4%.
The economy of Japan is between frail and healthy: the GDP came out worse than expected for the Q4 of 2022 at 0.2%. GDP is fragile, as the graph below shows, with alternating positive and negative quarters in the last two years.
The unemployment rate is very low, at 2.5%, the PMI manufacturing is very low at 48.9, retail sales rose to 3.8%, the money supply M2 slowed its rise, and consumption is expanding...
In conclusion, the economy of Japan is fragile, and it will be not a recession or a little one, but as consumption is expanding and unemployment is very low the BOJ will have to raise the interest rates by 0.25%. I don't think that they will raise interest rates to more than 0.75% because the economy is frail and the country has too much debt.
Last speech of the BOJ:
- Bank of Japan Governor Haruhiko Kuroda expects the country's consumer price growth rate to start slowing from February ( I don't think so for all the reasons given before).
- The Governor noted that the current monetary policy in Japan "corresponds to the need" of the economy.
- Following the results of the December meeting, the Japanese Central Bank unexpectedly widened the limits of the corridor within which the yield on ten-year government securities can fluctuate to plus or minus 0.5% from plus or minus 0.25% before.
- "The Japanese economy is now recovering from the pandemic," he said. "In fiscal 2023 (ending in March)," according to our expectations, economic growth will be about 2 percent."
- "The inflation in February will decrease".
USD: The inflation is at 6.5% and is going down because the FED has tightened up its monetary policy, the interest rate is at 4.75%. The economy is still in good health but the GDP is going down quart by quart as we can see in the graph below.
The unemployment rate is very low at 3.4%, the retail sales are declining, they are at -1.1, the consumer is still entrusted but is starting to decline, and the service PMI is declining but this last month it has increased.
Globally the economy is not bad but it is fragilizing progressively I think that the US economy will enter in recession in the next few quarters because consumption is declining and the US economy is based on consumption, but I also think that the inflation will drop, but more slowly than forecast with rebounds, and the interest rates will stop between 5.25 and 5.50% and will start to go downhill little by little because the economy will deteriorate and also the employees.
If the is a recession in the US (very probable) it will be worse than if it had been in Japan, because a recession = a drop in prices of energy = is bad for USD because the raw materials are exchanged in USD, and is also bad for the inflation so bad for the interest rates so bad for the USD.
There is another factor is the carry trade: When the FED starts to raise the interest rates the USD/JPY went up because a lot of institutions benefited from the difference between the interest rate of the two countries, now that there are rumours of a raise of interest rates in Japan all the institutions that buy the USD are repatriating their money to JPY.
Minutes of the FED:
- "It would be necessary to maintain a tight monetary policy stance until new data provided confidence that inflation was on a sustained downward path towards 2%, which would probably take some time."
- The Fed is obligated to have a hawkish speech, if people do not believe that the Fed will maintain its tightening policy, this expectation generates inflationary pressures.
- If employment remains strong, they will continue to tighten the monetary policy.
In orange, we can see the USD/JPY and in candles, we can see US10Y-JP10Y, we can see that the spread of the return of the 10Y of the two countries is correlated to the USD/JPY, normal. Like we can see the USD/JPY start to go down at the same time that the spread between the debt rentability of the two countries starts to go down, so this decrease in the USD/JPY is due to the increase of the JP10Y.
In conclusion, the economy of the US is good but it is becoming weak and it will enter a recession, the economy of Japan is very frail but it is improving. The inflation in the US is going down and the interest rates will soon have reached their peak, in Japan, the interest rates are at -0.1 and the inflation at 4% it not reached its peak, in a day or another the BOJ will have to raise its interest rates. The two are shelter currencies. In a horizon of 4 or 10 months, I am a seller on USD/JPY for all these reasons. But on the long term, I am bearish on the S&P 500 but I am not bullish on the USD (incoherent, no, because the USD is correlated to the VIX) because I think that the decrease of the US market will be due to a recession (bad for the USD) and because the results of the companies will be bad in the next quarters due of the monetary policy of the FED. The FED is hawkish and the BOJ is very dovish, I think that the two will change.
I entered the position with a test position of 1/3 of my total investment the 7 December at 137.3 and I entered my all position on 15 December at the level of 137.2. I put a stop loss of 1/2 of my total position on the level of 140 and the second one on 146.6, I put my take profit of 3/4 of the total position on 132, this is the 50% Fibonacci level from the start of the US rate hikes to the USD/JPY highs in October (this level had already reached and I take my benefits). For the remaining quarter, I put my take profit at 121.
Like I said before I'm sure there will be a rebound in US inflation which is why on the days when US inflation comes out, I will cover my position for 12h if the data is bad for USD and 48h if the data is good for USD.
I planned to take a second position of selling on USD/JPY at the levels of 135/137, for now in the short term, I think that the USD/JPY will increase because of the risk of continued rate hikes in the US, but in the long term, I am a seller on the USD/JPY.
I forgot to say that to take all those positions I had to convert my EUR to JPY and I covered this position with an inverse one (sell EUR/JPY with the same amount).
I didn't put everything in, I have other reasons to take this trade (the forecasts of the central banks and the private banks, the balance of trade, the capital flows, the debt, the geopolitics... ), but I didn't want to put too many things and too many graphs.
The analysis closes with the signature: Clément, 13 years old, Barcelona. The first thing I thought was that it was a mistake, so in my reply, I asked, "are you really 13 years old?" The answer was, "thank you very much for responding to me ! No, I am not 13, I am 14 years old, as I just got them I'm still making the mistake." Really great!
I asked Clément's permission to publish the analysis because it is well done and offers much food for thought. I did it with pride because I got confirmation that my books teach, to those who want to engage, the correct way to analyse the markets and this can only improve trading results. Every now and then, I receive e-mails from people who complain that my books explain so many aspects but do not provide a clear strategy. To all these people, who have little understanding of what they read, I advise them to go on the internet and search among the many gurus who advertise winning strategies, for the clearest one. Losing money is always the best lesson these traders can receive and will put them at a crossroads: "do I really learn how to analyse the markets or do I give up trading?"
I conclude with the last two words, "Merci Clément !"
Two days ago I received an e-mail from Clément with his analysis of Usd-Jpy. Before I make a few thoughts, I will quote the analysis exactly as it came to me, without changing a comma
