Explaining Short Yen/Long Nikkei Pair Trade.

short-yen-long-nikkei.md

Recently, I tweeted the following:

Short Yen/Long Nikkei pair trade worked all year; up 57% for 2013. Will continue into 2014 me thinks. http://t.co/llhIzUwHza

— Joe McCann (@joemccann) December 31, 2013

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And my friend Laurie Voss, @seldo, asked a completely legitmate question:

@joemccann How do you go long the Nikkei without getting clobbered by the fall of the Yen? (I am a noob)

— Laurie Voss (@seldo) December 31, 2013

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I'll try to explain, but be aware, I'm an economic enthusiast, not a professional.

Shinzō Abe, the current Prime Minister of Japan, has decided that he, with the help of the Bank of Japan, will attempt to regain the spot as the world's 2nd largest economy since they were ousted in 2010 by China by putting into practice the following economic policies:

• Create and track towards a 2% inflation rate target (the U.S. has had something similar for decades)
• Unleash heavy quantitative easing (in short, print money, which increases the supply of Yen thus devaluing it)
• Invest heavily in R&D and national infrastructure projects (economic stimulus, jobs, consumer spending goes up)

The idea is, if one prints money, the value of the Yen against other currencies, the US Dollar for example, goes down, which means the value of the dollar goes up against the Yen (short yen trade).

Traditionally a strong dollar is good for Japan as the majority of their economy's GDP is export-based and primarily those goods are priced in dollars. So when dollars go up in value, they make more money overseas, which is good for Japanese companies, which is good for the Nikkei (long the Nikkei).

However, this process has been accelerated thanks to an increase in import costs for energy (Japan imports most of their energy) thanks to a weak Yen (energy such as oil is priced in dollars) which causes an uptick in the core consumer price index (CPI) which leads to an increase in the cost of goods domestically (and starts to track towards the 2% overall inflation target). This means Japanese citizens have to pay more for the goods which increases revenue for Japanese companies, which is good for the Nikkei.

Moreover, with an increase in money supply, people have more money to spend and thanks to investments by the government in R&D and infrastructure projects, more people have jobs (unemployment rate has dropped from 4% to 3.7% as of October 2013) which means more consumers can spend more money which is also good for Japanese companies which is good for the Nikkei.

The portmanteau for this risky bet by the Prime Minister is naturally called Abenomics.

Hope that helps!