Yen Moves

While European drama continues to command attention, the yen has quietly depreciated and is now at its lowest level against the US dollar since last July and is at four month lows against the euro.  

There are several factors that appear at work.  Today's push lower corresponds to talk of strong Japanese demand for Thai baht related to insurance payouts from last year's floods.  The yen has declined about 8.5% against the baht since mid-January. 

The unexpected increase in the BOJ's asset purchases (QE) announced on Feb 14 helped accelerate the yen's slide that had already begun.  We suggested that BOJ intervention should be considered not when the yen is  strengthening, when the officials would have to fight the market, but instead intervene when the yen was already falling and officials would have the wind at their back.  In some ways the QE did precisely that.  

We have noted that thus far this year, foreigners had been buying few Japanese assets, while Japanese investors had stepped up their purchases of foreign assets.  In fact, the MOF data shows that Japanese money managers bought more foreign debt instruments in the first six weeks of the year than since at least 2005.

There are three key relationships for investors with yen exposure presently.  First, as the BOJ governor noted last year, the dollar-yen rate is correlated with 2-year interest rate differentials.  The differential was widening since the start of the month and extended by the BOJ's QE decision.  The differential now stands just below 20 bp, the highest since last August.  The 60-day correlation conducted on the level of the yen and the level of the rate differential now stands at -0.79.  

Second, is the relationship between the yen and oil.  Here we ran the correlations on the percentage change in oil and the percentage change in the yen.  There statistically insignificant inverse relationship over the past 60 days (-0.06).   The correlation on the level of oil and yen shows a -0.35  While more important still pales by comparison to the 2-year differential.  

Third is the relationship between the yen and the Nikkei.  Correlations on percentage change basis is not very fruitful.  For both 30-and 60 days, the correlation is slightly inverse.  However, what investors seem to be queuing off of is not the percentage change but the level.  The level of the yen and the level of the Nikkei are inversely correlated  0.81 over the last 30 days and -0.43 over the past 60 days.  When yen weakness is associated with Nikkei strength.

What has happened since the BOJ's surprise expansion of QE is that the Nikkei and the 2-year interest rate differential has become positively correlated after being inversely correlated in the last few months of 2011.   Widening interest rate differential, weighs on the yen and underpins the Nikkei, where many international fund mangers appear underweight.