Trading a Divergence in Correlation – JPY and SPX

As you all know, for so many years the JPY has been highly regarded as a “carry trade” instrument. But post financial crisis, that trade did not make much sense anymore since the interest rate differetials were so much smaller that they were pre financial crisis. Now with many major central banks at or near ZIRP, even some of the “best carry traders” like the NZD/JPY carry a 3% interest. For an institution, that trade is probably not work the risk (volatility). However, that trade (carry) exists in most traders minds (for whatever reason). I had a special guest Mark Dow on my webinar a few weeks ago as we discussed why this is. And frankly, in his view, he has seen this example of this “Pavlov’s Dog” behavior in many trades years after they realistically have not existed. However, that should be a topic of another blog somewhere down the road.

Getting back on point, over recent years the USD/JPY and SPX have enjoyed a very “parallel” relationship. I have argued many times the last leg of this market rally in 2013 was a combined effort by the Federal Reserve AND the Bank of Japan when they indeed launched their massive QE efforts.

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Present day, one of the reason why months ago I shorted the USD/JPY and went long JPY is there was a major divergence in the JPY and SPX. See article here in the FX Cafe.

Today, very similar setup. The SPX rallied back (retraced) about 80% of its sell off from 2 weeks ago. The USD/JPY? 50%. That “divergence” tells me that when the market would move down (like the SPX is today) the risk of a breakdown (larger) could be in store for the USD/JPY. So, it should be no mystery why the USD/JPY is testing 102.00 currently.

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Frankly, if the USD/JPY breaks the 101.00 major support in the coming days, stock market bulls may want to get defensive.

Blake Morrow

Chief Currency Strategist, Wizetrade

Disclaimer: I have been long JPY against most majors for last several weeks and also short equities via ETF’s

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