I’ve been thinking about USDJPY lately. I shared this with an economist friend of mine, who mocked my efforts, saying that FX has a large unpredictable volatility component which has defied all attempts at modelling. By economists. Luckily, sir, I am no economist!
So, caveat: Please don’t trade on this. These are the musings of an amateur, and I’m likely to be wrong. Assume that all of this is mistaken.
Anyhoo. You can see a big uptick that makes sense and then it fades, only to learn, as on Friday, that, while employment numbers were up, wages were down, or something like that, and the initial employment number caused some enthusiasm for USD, and then people thought about it, didn’t like the wage number, and USD dropped, lowering USDJPY. So goes the narrative. So news matters.
Be that all as it may, I’ve broken it down for myself as follows. I see 3 main effects:
- Interest rate parity theorem. Yen rates are basically flat around 0. So what matters is USD Treasury yield. The basic equation for USDJPY is F = S * (1+rUSD)/(1+rYEN). So watch rUSD.
- Investor allocation between cash, stocks and bonds. Fear up: Move to cash. Fear medium: Half stocks half bonds. Fear down: All stocks. A fear medium move will raise stock and bond prices simultaneously. Fear medium is an unstable state, we are more often in Fear Up or Fear Down. Moves into bonds drive bond prices up and rUSD down. Move from bonds to stocks drives bond prices down and rUSD up. Since Fear Medium is an unstable state, if you see Nasdaq or S&P index up, the likelihood is that rUSD will go up as well, as people leave bonds. Not a hard and fast rule. Call it a folk theorem. In Fear Medium unstable state, I expect USDJPY to trade in a range.
- Balance of trade. I don’t often see Nasdaq and Nikkei rise simultaneously. First of all they are traded alternately, Nasdaq when New York is awake and Nikkei when Tokyo is awake. My sense, though, is that an up Nasdaq day will be followed by a down Nikkei day. I haven’t studied this, just another folk theorem. My folk theorem: If things are getting more expensive in the US, as proxied by increased stock price, then Japan will need more income to buy US things, so they will lower their prices to get more dollars through increased volume of trade. And vice-versa. I consider Nasdaq up and Nikkei futures up to be an unstable state. In Nikkei up Nasdaq up unstable state, I expectUSDJPY to trade in a range.