Quote from cabletrader:
This is an interesting article I came across, I copied it but lost the link (and the chart). I know it applies to Yen and CHF but I wonder if the same applied to Eur when interest rates were low comapred with US rates and Eur was used as a carry funding currency (if it ever was, I can't remember!).
I'll leave it with you...
----------------------------------------------------------------------
JPY - Equity correlation is not sacred.
Posted by Paul Spirgel on Fri, 04/25/2008 - 3:28pm in Carry trades Equities Forex Pairs Trading USDJPY
Excerpt of research paper regarding the recent relationship between the Yen and Equity Markets. Courtesy of Bilal Hafeez, DB Capital Markets - London
In uncertain times, it is natural to defer to recent correlations to understand what is driving currencies. One such correlation is that between the JPY and equity markets. Indeed, since equity markets started their recovery in March, the yen has weakened, thus reversing some of the gains made on earlier equity market weakness. Though tempting to extrapolate this relationship further out, three points are worth noting. First, the correlation between the yen and (say) US equity markets goes through cycles. In the first half of the 1990s the correlation was close to zero, while recently it has reached all-time highs (see first chart) - over the coming months the risks of a decline in the correlation are therefore not insignificant. Second, the yen-equity correlation may not be specific to the yen, the Swiss franc also has recently had an extremely high correlation with equities . This suggests that the relationship may be due to the Swiss franc and yen typically being the lowest yielding currencies in the G10 world, rather than any specific country dynamics. Finally, the correlation appears to rise sharply when market risk increases. For example, when equity volatility or credit spreads rise, the correlation tends to rise .
The main implication of these points is that if risk appetite was to improve, the relationship between the yen (and Swiss franc) and stock markets would weaken. Relying on stock market trends alone to determine currency direction would then likely prove to be less fruitful than before. So if the current recovery in broader risk appetite was to continue, then stronger stock market may not be enough on its own to sustain further yen (or swiss) weakness.
---------------------------------------------------------------
