Death of an Inter-Market Correlation

by Pater Tenebrarum
Acting Man

A Curious Development in Japan

For a long time Japanese stocks have been little more than a mirror image of the yen – they would rise when the yen lost ground and fall when it strengthened. This has changed rather noticeably of late as the chart below illustrates. Incidentally, the Nikkei has broken out over a resistance level that has held it back since early 2018. Whether this breakout will hold remains to be seen, but so far it certainly looks convincing (perhaps it will require a retest).

Some of the major drivers of the previous negative correlation phenomenon were 1. the assumption that because Japan is an export-oriented economy, the stock market would on the whole benefit from a weaker yen, 2. the fact that domestic investors in Japan tend to repatriate funds whenever “risk assets” suffer a setback, so that declines in stock markets have automatically become associated with strength in the yen (and vice versa), and 3. the “carry trade”, whereby yen are borrowed at very low interest rates in order to buy higher-yielding foreign bonds, usually employing sizable leverage. As a rule, such positions come with fail-safe stop loss levels both based on bond prices and the exchange rate of the yen. When they are closed out, purchases of yen are triggered, exacerbating a budding uptrend.

Continue Reading at…