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USD/JPY and Dow: 90% Negative Correlation

Last updated 3/11/2009 10:14 AM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

The rally in the Dow Jones Industrial Average is doing nothing for USD/JPY, which held steady despite the more than 5 percent appreciation in U.S. equities on Tuesday.  In the past, such a voracious rally in stocks would have most certainly driven USD/JPY towards 100, but since the beginning of February, many forex traders may have noticed that USD/JPY is not responding to the moves in U.S. equities like it use to.

Between January 2008 and January 2009, the correlation between US equities and the USD/JPY was 79 percent.  This meant that 79 percent of the time, a rally in US stocks meant a rally for the U.S. dollar against the Japanese Yen.  This correlation was so strong that it became a trading model for many forex traders.  Unfortunately since February 1st of this year, the correlation has completely broken down .  Instead of being positively correlated with stocks, USD/JPY is now negatively correlated.  Since the beginning of Feb, the correlation between the Dow and USD/JPY is MINUS 91 percent.  In other words, over the past six weeks, 90 percent of the time, a sell-off in the Dow would be met with a rally in USD/JPY.

The Difference Between an Up and Down Day What is also interesting about this shift in correlation is that it has been predominately to the downside.  Given that U.S. equities have been primarily falling for the past month and change, the sell-off is not hurting USD/JPY.  A rally in the U.S. equities however has actually been neutral to marginally positive for USD/JPY.

What Triggered the Breakdown?

With US and Japanese interest rates at virtually the same levels, yield is no longer the driver of USD/JPY since both currencies are known as safe havens.  Japanese fundamentals have also been deteriorating significantly, making the problems in Japan too severe for Yen traders to ignore.  As indicated in the following chart, Japan has been running a trade deficit for the past 3 months and unfortunately the deficit is rising.  Corporations in Japan are reporting losses for the first time in decades and have been forced to layoff workers. With interest rates no longer a driver for the currency pair, USD/JPY traders have returned to fundamentals.  

Although we do not expect the negative correlation between the Dow and USD/JPY to last forever, it could be another few months before we see a positive correlation resume.  

Source: FX360.com

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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.