Why USDJPY Matters (Or The Carry Collapse Cometh)
By Tyler Durden
The yen’s strength may be tripping up U.S. stocks as the collape of the BoJ-inspired carry trade pressures leverage and risk-taking around the world. As Bloomberg notes, in the last 10 instances the yen rallied at least 1 percent against the dollar, the Standard & Poor’s 500 Index lost 0.8 percent on average, the most since at least 2008.
Andrew Brenner, National Alliance Capital Markets' head of international fixed income, confirms the weakness in US equities could be due to a breakdown in what's known as a carry trade, in which investors borrow money in a low interest-rate environment such as Japan’s to fund investments in higher-yielding assets.
And as Acting-Man.com's Pater Tenebrarum details, a stronger yen usually doesn’t bode well for stocks. We once again should warn that such correlations are never valid “forever”. The only thing one can always expect to happen in financial markets and the economy is constant change.
Still, given recent experience, we are wary that yen strength could be a sign that the recent party in “risk” will soon be derailed. On the other hand, we have to acknowledge that market internals have greatly improved due to the recent strong bounce in the commodity and industrial sub-sectors. At the same time, defensive sectors have only surrendered very little of their previous gains.
Options markets are largely in “neutral” mode – there is neither a great deal of enthusiasm in evidence, nor is there much fear. A similarly meaningless backdrop in options could however be observed in the July-August period as well, so this doesn’t necessarily mean much.
SPX daily: the SPX has returned into the area of congestion that contained it prior to the January sell-off. Put-call ratios look largely neutral at present, which is quite similar though to what they looked like shortly before the late August break – click to enlarge.
As we noted at the time of the interim lows in early to mid February, there was elevated crash risk due to the market’s proximity to important medium term support levels. However, once this risk had passed, we expected the SPX to rally back close to one of the previously established resistance areas.
It has in fact gone quite far in the meantime, by moving right back into the congestion zone it inhabited prior to the January breakdown. This continues to be in keeping with the 1962 and Nikkei 1990 analogs, which we have previously discussed (both examples for “unseasonal” market weakness in early January).
These analogs call for the next interim peak to be established sometime in the March to May period. If these models remains applicable (which is of course far from certain), then we are now in the phase designated “standard rebound from initial sell-off” on the chart below:
DJIA, 1961 – 1962: after a bout of weakness in early January, a …read more
Source: Why USDJPY Matters (Or The Carry Collapse Cometh)
