Great Chart: G10 policy rate vs. World equities

As more and more regions in developed economies have been put under a dramatic total lockdown amid growing concerns over Covid-19, central banks have started to cut rates aggressively in order to avoid a complete market meltdown. We saw in the previous week that both the Fed and the BoE held emergency meetings and cut rates by 50bps, the most since the Great Financial Crisis, benefiting from their positive benchmark interest rate to act faster than the rest of central banks. Economies already experiencing a NIRP policy (i.e. Sweden, Euro area) will probably implement or expand asset-purchase programmes in order to fight against a significant economic shock and therefore implicitly reduce their ‘shadow rate’, a rate first introduced by Fischer Black (1995) that can measure the effects of QE, to lower levels.

However, it is important to note that a significant reduction in benchmark policy rates globally has been associated with sharp equity sell-offs. This chart shows that in the previous two downturns, the GDP-weighted G10 policy rate was cut by approximately 4 percent and coincided with a global equity sell-off of 45% to 55%. Are we set for a similar story in 2020?

Chart. G10 policy rate vs. World equities (source: Eikon Reuters)

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Some Yen Charts…

In the past few months, investors have been questioning the Yen’s status of safe haven as the currency has constantly been depreciating in the past year despite the elevated uncertainty. The first surprising chart is the divergence between USDJPY and Gold prices (in USD terms). Figure 1 (left frame) shows that after co-moving strongly for 7 years, the USDJPY exchange rate decoupled from Gold (in USD terms). While Gold prices have been constantly soaring in the past year, and especially in recent weeks over growing concerns around Covid-19, USDJPY has remained steady oscillating around 109. In addition, we also noticed a significant divergence between USDJPY and US 10Y Treasury yield. Even though currencies have a variety of short-term drivers, the 10Y US-Japan interest rate differential has been one of the popular ones in the past cycle. As long-term interest rates in Japan have been trading around 0 percent in the past few years after the BoJ decided to keep the yield on 10-year Japanese government debt around zero percent, we just look at the US 10Y yield. Interestingly, demand for US Treasuries has been very strong in the past few weeks, leading to a sharp fall in the US 10Y yield to below 1 percent, while the move on the Japanese yen was more moderate (figure 1, right frame). Has the Yen lost his popularity in periods of market stress?

Figure 1

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Source: Eikon Reuters

First of all, even though the US Treasuries have been considered as the ultimate safe haven in the past 30 years, which explain the success of risk parity strategies during that period, the Japanese Yen remains the preferred currencies in the G10 space in periods of elevated price volatility. For instance, figure 2 shows that the Yen tends to appreciates strongly when VIX starts to surge; in the past 30 years, the JPY has averaged 44bps in monthly returns against the USD when the VIX was trading above 20, nearly four times more than the other traditional safe CHF (Swiss Franc).

Figure 2

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Source: Eikon Reuters, RR Calculations

Secondly it is important to know that the Yen is usually sensitive to the dynamics of the stock market and tends to appreciate in periods of equity sell-offs. Figure 3 (left frame) illustrates perfectly this example and shows a great co-movement between our favourite cross AUDJPY (also known as the proxy for carry trade) and the SP500. We can also see the strong relationship between USDJPY and Japanese equities in figure 3 (right frame); a cheaper currency is usually associated with higher equities in Japan (‘Pavlovian’ response).

Figure 3

fig3Source: Eikon Reuters

Hence, we do not think that the Yen has lost its status of safe haven and we saw last week that it has responded pretty well to the global equity sell-off, appreciating by nearly 5 figures against the greenback. In addition, to the exception of the US Dollar, the Yen has been strengthening in the past two years against most of the popular crosses such as EUR, GBP, AUD and CAD. Figure 4 (left frame) shows that the EURJPY and GBPJPY exchange rates have depreciated by 12% and 10%, respectively, since the start of 2018. We can also notice that the AUDJPY exchange rate has been constantly weakening amid elevated uncertainty, pricing in further weakness in global (ex-US) equities (figure 4, right frame). Is the AUDJPY actually right about the ‘fair value’ of equities.

Figure 4

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Source: Eikon Reuters

Figure 5 shows that the USDJPY exchange rate has been also nicely co-moving with the digital safe: Bitcoin. In the past 3 years, strength in the crypto market has been associated with JPY appreciation. Even though the relationship is pretty new, it will be interesting to see if both assets (JPY and Bitcoin) continue to receive support if price volatility remains high.

Don’t lose faith on the Yen, not now!

Figure 5

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Source: Eikon Reuters