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!
The relative movement of bond yields has been a relationship that works great sometimes, and not so great other times in recent years... what I had found was that the Japanese attempts to devalue via lower interest rates would backfire, when everyone else would devalue back against them. But maybe China is so large, that relationship does not work anymore. I am trying to work that out.
So for a while I think that argument that others would push back against them (via the interest rate channel and thus weaker FX) was the right one which is why you only saw the extreme broad-based JPY weakness last for a few years following the beginning of Abenomics. But now you're at a point where these other big DM central banks have reached their limit in terms of NIRP/ZIRP policies and are starting to reverse course. China is a very interesting one at the moment as normally by now I would have expected them to push back via a weaker RMB. However, I think the whole zero-COVID policy kind of throws a wrench in things right now. With the domestic economy still fairly weak because of zero-COVID, the current strength of the currency has arguably buffered their overall growth picture as the combination of a strong RMB plus still jammed up global supply chains has meant that their trade surpluses are at record levels despite the ultra-strong currency. As ironic as it is given all complaints over the last 2 decades about an artificially weak RMB, what the world needs right now (particularly the US) is actually a weaker RMB. Until/unless supply chains become unclogged, China is actually exporting inflation to the rest of the world via a strong ccy.
I guess my main point is that right now we're in a period where there really isn't any pushback against excessive JPY weakness by their other normal trading partners given most of them are dealing with inflationary pressures rather than deflationary ones. In that environment, most are more concerned about domestic ccy weakness not strength. Without some kind of about face by the BoJ and/or serious moderating in inflationary pressure, I would think this can continue for the time being.
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"?
Great note Russell I am very surprised by the chart breakout of USDJPY, DOWNTREND from 1990 broken, clearly I missed it,on Chinese equities, HSI long is a disaster YTD and to be or they were already “low” before Russian invasion, I’m being told that there some very different dynamics within Chinese equities in terms of repo They are so heavily shorted that you can receive circa 10% annualised yield on some indices but not all of them.
Interesting that the ASX is not showing weakness. Or could this be, as I think you have stated, that this is the "new normal' -- whereby Western stock markets now don't seem to turn bearish until the last moment?
A few years ago I studied the trading philosophies of Jesse Livermore, Bernard Baruch and Gerald Loeb. I can't help but wonder if their simple rule for trading is prudent now -- of beginning to average-up when an individual security has a 20% rise, and selling completely out of it when it has a 10-20% fall. In other words, just viewing a security in isolation and not in relationship. I adopted this approach when the Bloomberg agriculture index started its current bull run... as well as industrial metals, and energy.
If I do look at the relationships, they strongly support the price movement of commodities. Record low interest rates that the cbs will raise to some still pathetic level ... qualitative easing ... insane levels of government spending ... extreme inflation ... Paul Tudor Jones saying 8 or 9 months ago it was "all in on the inflation trade".
I am not sure why the hell so many people are not pulling the trigger and getting long real assets? Everything you would ever want to see is staring you right in the face.
I guess the biggest reason not to load up on inflation trades was looking at what Chinese property developers stocks were doing. Back in 2008, everyone also went long inflation, just as US housing was blowing up - and suffered 50% drawdown. Chinese property market is multiple times bigger demand for commodities, so you need to be comfortable with that...
We all have our strengths and our weaknesses. I am too trigger happy! My philosophy is that we need to work with people who have different characteristics to us. So that they have strengths where we have weaknesses, and vice-versa. That way we hopefully cover all bases. I notice that many people make the mistake of hiring people to work for them who are just the same as they are!
To be honest, I generally don’t read. But, this article caught my attention.
Um... thank you?
I suspect you have seen this from the “Wall Street on Parade” website https://wallstreetonparade.com/2022/03/these-3-charts-strongly-suggest-the-u-s-stock-market-has-an-invisible-hand-propping-it-up/
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!
The relative movement of bond yields has been a relationship that works great sometimes, and not so great other times in recent years... what I had found was that the Japanese attempts to devalue via lower interest rates would backfire, when everyone else would devalue back against them. But maybe China is so large, that relationship does not work anymore. I am trying to work that out.
Maybe you should write your own substack!?
So for a while I think that argument that others would push back against them (via the interest rate channel and thus weaker FX) was the right one which is why you only saw the extreme broad-based JPY weakness last for a few years following the beginning of Abenomics. But now you're at a point where these other big DM central banks have reached their limit in terms of NIRP/ZIRP policies and are starting to reverse course. China is a very interesting one at the moment as normally by now I would have expected them to push back via a weaker RMB. However, I think the whole zero-COVID policy kind of throws a wrench in things right now. With the domestic economy still fairly weak because of zero-COVID, the current strength of the currency has arguably buffered their overall growth picture as the combination of a strong RMB plus still jammed up global supply chains has meant that their trade surpluses are at record levels despite the ultra-strong currency. As ironic as it is given all complaints over the last 2 decades about an artificially weak RMB, what the world needs right now (particularly the US) is actually a weaker RMB. Until/unless supply chains become unclogged, China is actually exporting inflation to the rest of the world via a strong ccy.
I think a strong RMB and exporting inflation is part of the "plan"
I would agree :)
I guess my main point is that right now we're in a period where there really isn't any pushback against excessive JPY weakness by their other normal trading partners given most of them are dealing with inflationary pressures rather than deflationary ones. In that environment, most are more concerned about domestic ccy weakness not strength. Without some kind of about face by the BoJ and/or serious moderating in inflationary pressure, I would think this can continue for the time being.
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"?
Maybe... before the invasion of Ukraine i thought its weakness was inline with weakness in Chinese equities... which could be the same thing
Great note Russell I am very surprised by the chart breakout of USDJPY, DOWNTREND from 1990 broken, clearly I missed it,on Chinese equities, HSI long is a disaster YTD and to be or they were already “low” before Russian invasion, I’m being told that there some very different dynamics within Chinese equities in terms of repo They are so heavily shorted that you can receive circa 10% annualised yield on some indices but not all of them.
Interesting that the ASX is not showing weakness. Or could this be, as I think you have stated, that this is the "new normal' -- whereby Western stock markets now don't seem to turn bearish until the last moment?
Could be... but its another reason i returned capital... i liked currencies to agree with what equities were saying. But that does not happen now...
A few years ago I studied the trading philosophies of Jesse Livermore, Bernard Baruch and Gerald Loeb. I can't help but wonder if their simple rule for trading is prudent now -- of beginning to average-up when an individual security has a 20% rise, and selling completely out of it when it has a 10-20% fall. In other words, just viewing a security in isolation and not in relationship. I adopted this approach when the Bloomberg agriculture index started its current bull run... as well as industrial metals, and energy.
If I do look at the relationships, they strongly support the price movement of commodities. Record low interest rates that the cbs will raise to some still pathetic level ... qualitative easing ... insane levels of government spending ... extreme inflation ... Paul Tudor Jones saying 8 or 9 months ago it was "all in on the inflation trade".
I am not sure why the hell so many people are not pulling the trigger and getting long real assets? Everything you would ever want to see is staring you right in the face.
But you make a good point - over thinking is not helpful in this market. Sadly I am by nature an over thinker...
I guess the biggest reason not to load up on inflation trades was looking at what Chinese property developers stocks were doing. Back in 2008, everyone also went long inflation, just as US housing was blowing up - and suffered 50% drawdown. Chinese property market is multiple times bigger demand for commodities, so you need to be comfortable with that...
We all have our strengths and our weaknesses. I am too trigger happy! My philosophy is that we need to work with people who have different characteristics to us. So that they have strengths where we have weaknesses, and vice-versa. That way we hopefully cover all bases. I notice that many people make the mistake of hiring people to work for them who are just the same as they are!