New records for EUR/JPY

Few would bet against this level being tested. The single currency has endured three particularly intense selling periods over the past year, and judging by the price action of recent days, it appears that a fourth episode may just be underway. Most of Europe is in recession, at a time when governments are imposing sustained fiscal austerity and European policy-makers are still attempting to find lasting solutions to the sovereign debt and banking crisis. Meanwhile in Japan, the economy is growing again after last year’s tragic earthquake and tsunami. Prospects for the second half of this year still look respectable despite the fact that the currency is over-valued and demand for exports has waned. Like the US dollar, it is the Japanese yen that benefits most whenever global risk appetite diminishes.

Although EUR/JPY has been a preferred way to bet on a declining euro for many traders, it should come with an important health warning. Europe’s fundamentals may appear awful right now but Japan’s are none too special either. National debt is astronomical at over 200% of GDP; the government is incredibly reliant on domestic saving to fund itself; tax revenue covers only one half of government spending; and the trade sector has consistently been in deficit since last year’s disastrous events.

Right now, with Europe heading into a slow-motion financial implosion, Japan’s shortcomings have been pushed into the background. Eventually, however, they will come forward and attract sustained opprobrium. The direction of travel still favours a lower EUR/JPY, but the risk in this trade is definitely growing. As such, tighter stops than usual are required.