USD/JPY and US Stocks: Why are they Moving in Different Directions?

February 19, 2009

In my Daily Currency Focus on FX360, I talked about Why USD/JPY and Equities are 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 - see chart) 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.

Posted in 2009 japanese yen, 2009 japanese yen forecast, forex blog, usd/jpy