We're now about 200 basis points below where we were last Thursday on USD/JPY (yen higher), which is when I posted an update to my short USD/JPY (long yen) trade.
In that update, I advised traders to stay long the yen as the weakness would soon fade.
The week before that, I spelled out my base rationale for a long yen position and it mostly came down to the fact that the tax hike in Japan -- the first in 17 years -- would probably create a huge short squeeze in the currency. This would be likely because taxes remove currency from circulation and also remove yen reserves from the banking system. It makes the yen harder to get and with speculators short the yen at historically high levels, the potential for a huge rally is very real.
I believe the yen rally has now begun in earnest, so we will see this carry for some distance, probably until every last spec short position has been bought back (and then some). At this point, I would not be looking to sell rallies, at least until we get to where speculators have become net long and I suspect that might take some time. I'm sure when that happens we will also be hearing a lot of the same, misinformed reasons as to why we should be buying the yen, just like we heard reasons to sell when it was trading on its lows (Japan stimulus, yen printing, etc.).
Looking around at other currency markets, I believe the euro's correction is now over and you should expect to see the euro climb to at least $1.40 if not higher in the near future. The market is very heavily short euro, for all the wrong reasons once again. Most people are looking at weak growth or getting all worked up about possible ECB rate cuts, when the real factor supporting the euro is austerity plain and simple.
I have explained the austerity effect many times. It's similar to the tax hike/bullish yen argument that I outlined above. Basically austerity removes euros from the monetary system because the government is collecting more euros in the form of taxes than it is recycling back via spending. That makes the euro harder to get. The effects can manifest in the form of a "low grind up or a very violent spike, depending on the magnitude of the austerity measures (100% taxation and no spending would make the euro go to infinity immediately). But even a gradual process is nonetheless relentless. It persists until the austerity has ended (and I see no end in sight).
If one were to look at the correlation between interest rates and currencies or GDP and currencies, (and I have, many times) one would see little if any correlation. Yet the belief on the part of most people is that these are the things that drive foreign exchange rates. They're not.
At the time of publication, the author had no positions in any of the securities mentioned.