Weekly Chart: TOPIX vs. USDJPY

As we always like to look at the Japanese Yen charts (USDJPY, AUDJPY, MXNJPY) as a sort of alternative barometer of investors sentiment and overall financial conditions, we chose an interesting chart this week that shows a scatter plot of the Japanese equity market (TOPIX) with USDJPY. The two assets have shown a significant relationship over the years, especially since Abe took office in Q4 2012 and the BoJ introduced QQME (i.e. extremely accommodative monetary policy) on April 3rd 2013. Investor Kyle Bass was one of the first to introduce the term Pavlovian response to this ‘weaker yen, higher equities’ relationship in Japan, which brought a lot of ‘macro tourists’ instead of long-term investors.

However, we noticed that the relationship between the Yen and the TOPIX broke down in Q2 2017. While the Japanese equity market has continued to soar over the past few months, currently flirting with the 1,900 psychological level (its highest level since 1991), USDJPY has been less trendy and has been ranging between 107 and 114 (see divergence here). Hence, we decided to plot a scatter chart between the two assets using a weekly frequency since 2001.

As you can see, a strong Japanese Yen (i.e. USDJPY below 100) usually goes in pair with a weak equity market. For instance, we barely see the TOPIX index above 1,000 when the USDJPY trades below the psychological 100 level. However, as the exchange rate increases, we see more dispersion around the upward sloping linear trend; for a spot rate of 120, we had times when the TOPIX was trading at 800 and other times when it was trading at 1,800. We did a simple exercise and regress the exchange rate returns on the equity returns (both log terms) to see if we get some significant results, using the following equation:


As you can see, the coefficient Beta is economically and statistically significant at a 1-percent level. Using 16 years of data, we find that a 1-percent increase in USDJPY spot rate is associated with a 0.76% increase in the stock market.

We highlighted the point where we currently are in the chart (Today), which is a TOPIX at 1,889, its highest level in the sample, for a USDJPY spot rate of 112.80. We can notice that the point is located at an extreme level of dispersion, and the question we raised a few weeks ago was ‘Can the divergence between the equity index and the exchange rate continue for a while?’

We think that the stock market in Japan will struggle to reach new highs and generate some potential interesting returns in the months to come due to the poor performance of the banking system (strong weigh in the index) and the constant decrease in the effectiveness of the BoJ policy measures. We mentioned a month ago that the Japanese Yen was 26% ‘undervalued’ relative to its 23Y average value of 99.3 according to the Real Effective Exchange Rate (REER valuation) (see here), hence we find it difficult to imagine a super bear JPY / Bull TOPIX scenario. In addition, we also raised the fact that the current level of oil prices were going to deteriorate Japan Trade Balance in the future (see here), pushing back the current account in the negative territory and potentially impacting the stock market.

Chart: Scatter plot of TOPIX vs. USDJPY – weekly frequency (Source: Reuters Eikon) 


BIS Nominal and Real Effective Exchange Rates (EER): NEER and REER

Abstract: In this article, we introduce the two effective (i.e. multilateral) exchange rates that measure the value of a specific currency in relation to an average group of major currencies: the Nominal Effective Exchange Rates (NEER) and the Real Effective Exchange Rates (REER). Both are calculated by comparing the relative trade balance of a country’s currency against each country within the index, but the REER is adjusted by the ratio of domestic price to foreign prices.

Using the BIS time-varying weights, we also look and comment the development of the CNY NEER and JPY REER over the past twenty years.



Purchasing Power Parity (PPP) and Real Exchange Rates (RER)

Abstract: In this article, we introduce the Purchasing Power Parity, a theory that stipulates that in the long run, the exchange rate between two countries should even out so that goods essentially cost the same in both countries. The research organizes as follows. In Section 1, we introduce the PPP theory based on the work of Dornbusch (1985), presenting the absolute and relative versions of PPP. In Section 2, we provide three difference analysis and compare the exchanges of Canada, Britain and Japan  (all vs. USD) against their PPP values using Eurostat-OECD data. Section 3 presents the Real Exchange Rate (RER), a rate which seeks to measure the value of a country’s goods relative to the those of another country at the prevailing exchange rate.

LINK ===> PPP and RER


(PPP Value relative to the US Dollar)