Why are USD/JPY And Equities Decoupling?

Last updated 2/19/2009 5:32 PM ET (GMT -5) 1 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• WHY ARE USD/JPY AND EQUITIES DECOUPLING?
• EUR/USD: PRICING IN MORE AGGRESSIVE CUTS FROM ECB
• GBP/USD: RETAIL SALES ON TAP
• USD/CAD: LEADING INDICATORS SEE LARGEST DROP SINCE 1982
• AUD/USD: MOODYS SET TO REVIEW AUSTRALIAN BANK RATINGS
• USD/CAD: LEADING INDICATORS SEE LARGEST DROP SINCE 1982
• USD/JPY: BOJ ANNOUNCES ADDITIONAL MEASURES TO LOOSEN CREDIT MARKETS

EXPECTATIONS FOR UPCOMING FED MEETINGS

WHY ARE USD/JPY AND EQUITIES DECOUPLING?

Based upon the price action in the currency market, one would assume that risk appetite is improving.  However, if you took a look at the sell-off equities, it suggests otherwise.  Over the past few months, there has been a strong correlation between these two instruments with equity market weakness driving USD/JPY lower.  Unfortunately this correlation has decoupled today, leading currency traders to wonder which asset correctly reflects the market’s appetite and why there is a decoupling.

Lower Volatility is Driving USD/JPY Higher

When equities and USD/JPY are moving in different directions, we like to look at the commodity and Treasury markets for more clarity on investor sentiment.  Interestingly enough, gold prices have fallen today while bond yields have risen, which is in line with stronger risk appetite and the rally in USD/JPY.  As for why the decoupling is a happening, we turn to volatilities.  The volatility in USD/JPY (as measured by 3 month at the money options) has fallen to the lowest level since October.  As “risky assets,” the yen crosses and other high yielding currency pairs are sensitive to the level of volatility in the foreign exchange market.   Carry trades tend to sell off in environments of high volatility and rise in environments of low volatility.  This inverse correlation is illustrated in the following chart.  The white line represents the volatility of 3 month at the money USD/JPY options while the green line is the price of USD/JPY.  The decline in volatility is helping to boost the market’s appetite risk and restore demand for higher yielding currencies.  Also, investors may finally be responding to the weakness of Japanese economic data and the new measures announced by the Bank of Japan last night.  If volatilities stabilize, then we may see USD/JPY and US equities move in lockstep once again.

  Rising Inflation Not a Concern, Focus on Growth

There were a number of US economic data released this morning and they sent conflicting messages about the US economy.   Starting with the dollar positive news, producer prices rose 0.8 percent in the month of January, more than double the market’s forecast.  Although this is the first increase in prices since August, the rebound is not enough to draw away from the Fed’s disinflation or deflation fears.  In the following video of Bernanke’s speech yesterday , he explicitly said that there is little risk of unexpectedly high inflation in the medium term and instead, we expect inflation to be quite low for some time.  Leading indicators also increased for the second month in a row thanks to rising money supply, the interest rate spread and consumer expectations.  There was also plenty of dollar negative news to go around.  Jobless claims remained at 627k, but continuing claims hit a cycle high of 4.987 million. Manufacturing activity in the Philadelphia region also hit a record low, reflecting the overall weakness in the US manufacturing sector.  Inflation is not a concern at this point but the number of people on unemployment rolls is very worrisome.  On Friday, consumer prices are due for release.  The rise in producer prices suggests that we should see a similar rebound in CPI.

EUR/USD: PRICING IN MORE AGGRESSIVE CUTS FROM ECB

Although the Euro gained strength against the US dollar today, most of the gains were achieved during the European and early US trading session.  French President Nicolas Sarkozy announced a EUR 2.65 billion stimulus package that will lower taxes for low income households and give bonus payments to the unemployed.  After the release of the Philly Fed numbers at 10:00am ET, the EUR/USD spent the rest of the day giving back its earlier gains.  Interest rate traders are banking on more aggressive rate cuts from the European Central Bank as they have driven 3 month LIBOR rates to record lows.  With the trouble brewing in Eastern Europe, easier monetary policy may be needed to help the region as a whole. Germany has avoided talking about whether they plan on bailing out member nations which is not much of a surprise considering the fact that they are forbidden to do so according to the Maastricht Treaty.  In the end however, the constructors of the Maastricht Treaty may not have considered the severe problems that member nations may one day face.  On Friday, service and manufacturing sector PMI numbers are due from individual countries and the region as a whole.  We expect the numbers to be weak given the drop in consumer spending, industrial production and factory orders.  

GBP/USD: RETAIL SALES ON TAP

The British pound rebounded against the US dollar but weakened against the Euro today.  Public Sector Finances deteriorated significantly last month.  Falling tax receipts and rising unemployment benefits have put severe strain on the pocketbooks of the UK government.  The situation will only worsen as the government officially classifies Lloyds Banking Group and the Royal Bank of Scotland as public-sector entities, increasing the debt burden of UK taxpayers.  Retail sales are due for release on Friday.  Consumer spending has been surprisingly resilient with retail sales rising 1.6 percent in December.  Although BRC retail sales saw a material increase, consumer confidence deteriorated significantly last month, suggesting that UK consumers may finally be cutting back.  

USD/CAD: LEADING INDICATORS SEE LARGEST DROP SINCE 1982

The Australian, New Zealand and Canadian dollars strengthened against the US Dollar as the price of oil jumped 7% on falling inventories. Canadian Leading Indicators experienced the biggest contraction since 1982, adding to concerns that the country, which turned its first trade deficit in 30 years, will see a deeper recession.  The Leading Indicators fell for the 5th consecutive month, largely due to the weakening housing market and a drastic decline in stocks. Canadian lending to businesses increased by 8.4% in the 4th quarter of 2008 as rate cuts showed to be more effective in Canada than in other countries. As a result, officials seem to be optimistic that the economy will expand by 3.8% in 2010 after shrinking 1.2% this fiscal year. Tomorrow, Canada is set to release its CPI figures which are expected to slow further as prices of commodities continued to decline in the month of January.  However we believe that the surprise could be to the upside given the uptick in the price component of IVEY PMI. New Vehicle Sales in Australia declined in the month of January as consumers started to cut back on the big tickets items. Moody’s Investors Service is set to review Australian banks’ credit ratings as it predicts the economy to enter a recession in the upcoming year.  The Australian government believes otherwise.

USD/JPY: BOJ ANNOUNCES ADDITIONAL MEASURES TO LOOSEN CREDIT MARKETS

The Bank of Japan left interest rates unchanged last night at 0.1 percent and announced a number of additional measures to alleviate the credit markets.  With the economy facing the largest contraction in more than 30 years, it was not surprising to see the government unveil new initiatives aimed at pumping more money into their financial system.  Last night, they announced a corporate bond purchasing facility, extended the duration of their existing corporate financing facility and pledged to conduct operations to facilitate financing on a weekly basis.  Bank of Japan Governor Shirakawa stressed that the central bank is not returning to Quantitative Easing and are not adopting the US’ credit policies even though they are purchasing corporate debt and injecting liquidity into the bond markets to get companies lending.

GBP/USD: Currency in Play for Next 24 Hours

The currency in play for the upcoming 24 hours is GBP/USD based on the release of U.K.’s Retail Sales at 9:30GMT or 4:30AM EST and U.S. CPI at 13:30GMT or 8:30AM EST. Since coming off a multiyear low the pair is unable to find any distinctive trend, currently lingering in Range Trading Zone which we establish using Bollinger Bands. With heavy economic releases from both the US and UK, the pair has a potential of entering either a Buy Zone or a Sell Zone of the Bollinger Bands. Current resistance is originating around 1.4610 which is 1st Standard Deviation of the Bollinger Bands as well as 50% retracement of December 2008 high and this year’s low. As the pair is trading closer to the Sell Zone of the Bollinger Bands, support is placed between 78.6% retracement of December 2008 high and this year’s low at 1.4025 and an important psychological level of 1.4000.

Comments (1)

Vratka

May 25, 2009 at 07:48 AM ET

if you need any closer informations about ratings of various banks - have a look at www.bank-ratings.net

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.