The U.S markets showed no signs of resilience last week as the major indices plummeted to new lows. A shortened trading week turned out to be a sell off as the major indices dropped by over 6%. The banking system yet again hit the news as rumors of nationalization came out, extending the selling pressure. Recently-hit banks dropped by double digit numbers, as investors lost their confidence in the new stimulus plan.
On the Forex market the Dollar raced forward as economic data from across the globe hit investors, showing them that global economies still have further obstacles to overcome. European economies are showing a gloomy situation while Britain, once known for its high-held economy, is now dealing with currency erosion caused by a pessimistic economic outlook.
For over a year now, central banks from across the globe have engaged in an interest rate cut frenzy, to try to stimulate their economies, but unfortunately they haven't been able to keep up with the market's trend. Falling equities have caused central banks to lift their harnesses off the economy, slashing rates while pumping money into the system.
Cash Flow
When taking a walk down history lane, it seems like only yesterday Forex investors were racing towards higher interest rate currencies trying to grab the next up trend. Countries like Australia, New Zealand and Britain were presenting phenomenal returns, while even the U.S, a country reaching only a 5.25% yield, managed to attract investors. Some used to call it a "buy and hold" strategy or "a carry trade". Investors became familiar with the various traded asset's directions, knowing that- as stocks go up, so do particular currency pairs. It all made sense; Investors knew that If stocks were gaining strength, central banks were more than likely increase their rates to control the level of growth, hence making their currency gain value against other low yielding ones. During that time carry trades also became a popular form of trading as large corporations raced to grab interest rate differentials, between high yielding currencies and low yielding one; like the Japanese Yen. Currency pairs like the USD/JPY increased enormously in value due to the increase in demand.
As the housing bubble burst towards the end of 2007, stocks began to plummet. Interest rates quickly followed, while the expectation of lower rates dragged along currencies. By taking a glance at the chart below we can see a mirror-like resemblance. Throughout the years, the Japanese yen traded in a negative correlation to the S&P500, meaning that as stocks increased currency investors went haywire, selling low yielding currencies and buying higher yielding ones like the USD. As stocks began to drop, money sailed back into the Yen or other low yielding currencies, as those same investors closed their positions, taking their profits. By taking a brief glance at the USD/JPY one can also see that the chart resembles the S&P500.
Why aren't currencies now going in their expected direction?
For a couple of weeks, dodjit's market briefings have been stating that a divergence between the USD/JPY and stocks has begun to occur. While one might think that risk appetite is slowly developing in the markets, stock movement is painting a completely different picture. The Dow industrial average touched its 2002's lows last week, while other indices dropped to prior lows. Funny enough the USD/JPY is gaining value.
One must remember that the USD/JPY can gain due to many different reasons, for example Japan's economy could be in a more severe situation than the U.S, therefore forcing the USD/JPY to rise, despite the U.S's pessimistic outlook. Or in other words, the Japanese Yen is devaluating at a faster rate than the USD.
By comparing the two currencies to a neutral asset, such as Gold we can see that while the USD has decreased by 18% in Gold value since mid January, the Japanese Yen has dropped by over 23%. Deterioration in the Japanese economy and a pessimistic GDP outlook has shifted sentiment towards the least drowning currency - the USD. One must note that while many consider the Dollar to be a strong asset, chart analysis is telling us that it is receiving its strength due to the fact that it seems the least of two evils.
Where to now?
By taking a glance at this pair, one can see that the price is now trading around major resistance. In addition, when analyzing the Dollar index more thoroughly, one can see that it has now touched major resistance and is holding firm on trend line support. Should the Dollar index drop, increasing momentum could cause the USD/JPY to lose strength despite a weakening Yen.
One thing is for sure, it will be interesting to see if the USD/JPY and the USD index remain correlated, especially as investors know the state of the Japanese economy, but are quite unsure regarding the U.S's.
*charts are courtesy of stockcharts.com and netdania.com
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