Hello Russell, Is it possible that the AUD is telling us more than "China MAY invade Taiwan"? Given the complete lack of strength in the AUD, is it telling us that "China WILL invade Taiwan"?

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To be honest, I generally don’t read. But, this article caught my attention.

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Hi Russell,

First off I really have enjoyed reading your Substack since I fist subscribed a couple of months ago. I listened to your podcast interview with Grant Williams last year and it really resonated with me. I've also really enjoyed the series on clearing house risk.

As someone who has spent their career trading FX I do have some thoughts on JPY. With regards to JPY weakness over the last couple of years (and especially so far this year), I think it's important to look at what is going on in US rates during this most recent bout of indigestion that we are seeing in risk assets. Most people tend to think of JPY as being negatively correlated with equities, but in reality the strongest long-term correlation for USDJPY in particular is with US rates (USDJPY down when US yields down and vice-versa). If you look at the correlation of monthly returns in USDJPY vs SPX and the MSCI All-world index going back the last 30 years they are basically zero. Where I think that so many get tripped up is in the fact that for much of that period, the majority of risk-off episodes saw lower UST yields as the market worried about disinflation/deflation and the Fed inevitably cutting rates. During these periods you also would see JPY strength reflected primarily via lower JPY crosses (AUDJPY, CADJPY etc) as the USD still tends to do very well vs cyclical currencies in periods of risk off.

This time around though as you've said, the proximate cause of current risk woes is actually higher rates and more hawkish DM central banks brought about by much higher inflation from multiple supply shocks. The Fed and other DM central banks now find themselves in a situation where they really can't (yet) pivot back to being dovish even if growth slows and risk assets fall given just how far above target inflation is. In this light, JPY weakness arguably shouldn't really be that surprising - particularly as Japan are huge importers of energy in the post-Fukushima world. From a terms-of-trade shock perspective (and when looked at through the lens of the yield moves), you could say that USDJPY arguably looks about right.

One thing I would say (which you highlighted above) is that you could make the case that a number of these commodity exporting countries that are going through major positive terms-of-trade shocks (AUD, CAD, NOK) have currencies that don't yet accurately reflect those positive shocks. Arguably, the rallies in things like AUDJPY, CADJPY and NOKJPY may only just be getting started if this commodity bull cycle continues.

The last thing I would mention is that even with every other DM central bank either hiking or having pivoted hawkish, Kuroda and the BoJ seem determined not to move in that direction for at least another year or two.

Sorry for the slightly long-winded reply, but I think the relationship of JPY to risk-assets is one that is not so simple as JPY being a safe haven in times of risk aversion. Interested to hear your thoughts and really enjoying the writing!

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