Among all the potential compatible candidates that show an interesting correlation vis-à-vis the USDJPY (i.e. 10-year US-Japan interest rate differential, Topix index …), I chose this week to overlay the currency pair with the US 2Y10Y yield curve. If we look at the past three years of data, we can notice an interesting development that has started since mid-April of this year. While the US yield curve and USDJY has shown strong co movement between January 2015 and April 2017, it has been a different story over the past 8 months.
In the US, the yield curve has constantly been falling and is currently trading at 51.5bps half the value where it was sitting in April 2017. On the other hand, the Japanese Yen has been oscillating within a 7-figure against the green back, between 107.50 and 114.50. What is interesting about this divergence is that it started more or less at the same time of the Topix vs. USDJPY divergence, with Japanese equities soaring from 1,500 to 1,800 and a Yen mean reverting around 111 against the USD ( see tweet Topix vs. USDJPY).
The question now is: How long can this divergence persist in the near to medium term? The current level of the US yield curve has raised the concern of many market participants as in theory it is viewed as a strong predictor of future recessions. Looking at economic and financial data, I don’t personally believe that we are very close to a potential recession in the US; in addition, the yield curve is still far from its extreme lows of -20bps and -95bps we saw in November 2006 and May 2000 (if we just look at the past 30 years of data). However, I think that we may see some US Dollar weakness against the Japanese Yen, on a back of slowly disappointing fundamentals (easing all the excitement on the expected Fed rate hikes) and geopolitical uncertainty. Moreover, the Japanese Yen is 26% ‘undervalued’ relative to its 23Y average of 99.3 according to the real effective exchange rate ( see JPY REER).
Chart: USDJPY (Candlesticks, rhs) vs. US 2Y10Y yield curve (Source: Bloomberg)