JOHN TAYLOR: 2013 Will Start With Markets Up, And Then There Will Be Trouble

John Taylor

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Dec. 27 (Bloomberg) — After four decades in the foreign- exchange business, John Taylor says a further depreciation of the yen versus the U.S. dollar is one of the surest bets he sees going into the new year.Taylor, founder and chairman of New York-based currency hedge fund FX Concepts LLC, anticipates the yen will weaken to 90 per dollar for the first time since June 2010 before a resumption in risk aversion prompts investors to return to traditional refuge currencies such as the greenback.

“All our cycles and models tell us something is going to happen in February that will turn the markets around,” said Taylor, who uses proprietary quantitative models and technical analysis to predict trends and patterns in currency markets. “The year will start off with risk-on, stock markets up and then it’s going to get into trouble later.”

FX Concepts’ Global Currency Program, a $908 million investment fund, is up 0.41 per cent this year through last month. Profits in so-called carry trades, through purchases of higher yielding currencies including the Peru’s sol and Colombia’s peso funded with dollar- and euro-denominated loans, have helped the company’s flagship fund rebound after losing 19.41 per cent in 2011. The program’s annualized return since March 2001 is 6.8 per cent, according to the firm’s website.

The yen is down 14 per cent this year, posting the biggest depreciation among the 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted Indexes.

‘No Reason’
Against the dollar, the yen weakened today to 85.84, the least since September 2010. Japan’s Prime Minister Shinzo Abe said yesterday he would push for “bold monetary easing.”

Abe was approved as prime minister by Japan’s parliament after his party won a landslide victory in the Dec. 16 vote, pledging to weaken the currency, stoke inflation and achieve 3 per cent nominal economic growth. Japan’s deflation-plagued economy has contracted 7 per cent since 2007 as six prime ministers, including Abe in his first term, failed to reverse the course.

“There is no reason for the yen to be strong now,” Taylor, 69, said during a telephone interview from the company’s 3 Park Ave. headquarters on Dec. 20. “The yen could go to 90 versus the dollar into early February before reversing course.”

Best Forecasters
Taylor isn’t alone in forecasting a short-lived slump. The five best yen forecasters — Westpac Banking Corp., Monex Europe Ltd., Citigroup Inc., UniCredit SpA and Morgan Stanley –predict the yen will trade at 83 by year-end, according to the median of their estimates from a Bloomberg News survey last week. A compilation of 26 estimates from after the election predicted a weakening to 88 in December, based on the median.

The dollar, which FX Concepts is wagering will depreciate as market participants are unnerved by U.S. politicians’ seeming inability to avert $600 billion in tax increases and spending cuts that have become known as the fiscal cliff. Taylor said. The U.S. currency will begin a rally in February that will last into the third quarter, said Taylor, who started Chemical Bank’s Foreign Exchange Advisory Service in 1972. Gains will likely be aided by a resumption in financial turmoil in Europe, he said.

“I have no idea where the blow-up is going to come in Europe, but the probability is really high that one is coming,” said Taylor, who is sticking with his prediction first made in 2010 that the euro will trade at one-to-one versus the dollar. “It could be Cyprus — which is one hell of a mess. Spain is also a mess. I don’t know what the trigger will be, but there will be one.”

Central Banks
Cyprus, the fifth euro-area nation to seek a financial rescue, faces a more serious fiscal situation than Greece, Luxembourg Prime Minister Jean-Claude Juncker, who heads the group of euro-area finance ministers, said Dec. 14 in Brussels. The Cypriot government is negotiating with the euro area and the International Monetary Fund for aid.

Unprecedented monetary easing by central backs is likely to lead to disruptions in global financial markets, Taylor said. This is even with measures, such as the European Central Bank’s pledge to provide support to member nations that are committed to reforms, driving yields on Spanish and Italian debt lower relative to benchmark German debt, he said.

“The Federal Reserve and other central banks are being so heavy handed in the market, it’s going to end up badly,” according to Taylor, who said the lack of volatility in currencies and other assets reminds him of 2006 and early 2007, or the final phase of the period dubbed the “Great Moderation,” which ensued in the mid-1980s as increased global central bank transparency and actions helped stabilise inflation and business cycles.

Managed Phase
“We thought we knew things were good in 2007, but things didn’t work out that way,” said Taylor, admitting FX Concepts’ wagers in 2012 that currency volatility would rise hadn’t panned out. “Governments are forcing us into a managed currency phase. There is one thing we know, that governments can’t manage things like this. At some point, the whole thing is going to blow up.”

Volatility on options on major currencies fell to a record low of 5.73 per cent in June 2007, before surging to a record high of 26.55 per cent in October 2008, the month after the bankruptcy of Lehman Brothers Holdings Inc. triggered a global credit freeze and worst financial crisis since the Great Depression, according to a JPMorgan Chase & Co. index. The bank’s index averaged 10.66 per cent over the past two years.

Monetary Stimulus
The Fed will add in January $45 billion in Treasuries to the $40 billion in mortgage bonds it’s currently purchasing a month in its third round of bond buying, known as quantitative easing. Meanwhile, the Bank of England and the Bank of Japan are buying bonds as part of unprecedented global monetary easing over the past five years. The ECB has proposed to buy bonds of cash-strapped nations and has cut benchmark rates to record lows. The Swiss National Bank has capped gain in the franc against the euro.

The largest currency traders have said foreign-exchange revenue fell this year as central-bank policies stifle price swings and cut volumes. Deutsche Bank AG, the biggest dealer based on Euromoney Institutional Investor Plc data, said narrower margins cut revenue “significantly” in the third quarter.

“The governments would like the swings in exchange rates to be very small,” said Taylor, who titled his December investment outlook client letter “Overconfident … Again”, and was suspect that “political stability, low volatility, quietly climbing equity markets and calm currency/fixed income markets dominate the future as far as the eye can see.”

“This is causing a mispricing of many things,” Taylor said in the telephone interview. “At some point, this is going to catch up with us. It may not be for a while, but it’s probably not more than five years away.”

–With assistance from Monami Yui and Hiroko Komiya in Tokyo. Editors: Dave Liedtka, Paul Cox

To contact the reporter on this story: Liz Capo McCormick in New York at [email protected]

To contact the editor responsible for this story: Dave Liedtka at