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Understand the Link Between USDJPY & SPX500

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time is money

time is money

USDJPY has taken a reversal of direction in the last 15 months. If you look at a long term chart, since 1998, USDJPY has dropped from a decade high of 147.66 in 1998 before the Asian Crisis spread and then bottomed over the years crises at 75.55 in 2011. Alongside the USDJPY in recent months, the stalwart S&P500 has been highly correlated and as you will see, if the USDJPY uptrend is just in its first leg, then the SPX500 could continue its impressive uptrend as well.

Understand the Driving Force behind the USDJPY Uptrend

We've written about the major turn in the USDJPY but there is still more to consider as 2014 gets underway. The driving force behind the JPY weakness has been the quantitative easing efforts where the government of Japan has set up an economic program to sell the local currency which weakens the JPY, thereby making Japanese exporters more competitive in the global marketplace and allowing the Bank of Japan to hit their 2% inflation or price stability target.

The first Bank of Japan or BoJ meeting of 2014 is this week, the 22nd of January.   Over the course of 2014, there are a couple of economic hurdles the BoJ will likely have to address which will tell you and the overall market the longevity of JPY weakness which is critical for price stability and a healthy economy. 

The Hurdles 

In light of the consumption or sales tax being hiked this year, the Bank of Japan is expected to introduce another round of quantitative easing or QE which will should weaken the JPY further and allow the 2% inflation target to be hit if not well surpassed to the upside. However, price and market confidence are key things that will be in focus for the JPY in 2014. Therefore, a key price level on USDJPY is 105.57.

If USDJPY cannot break above 105.57 (the 61.8% Fibonacci Retracement level of the 2007-2012 Range) and confidence begins to wane from many large players like banks, hedge funds, pension reserve funds that hold large amounts of Japanese Government Bonds or JGBs which could dictate the direction of the JPY going forward, then the rally for now could become tired and possibly too heavy to continue.

However, the hurdles appear now to be easily overcome given recent data out of Tokyo. If the Consumption Tax introduced by Bank of Japan is all but dismissed and the Consumer Price Index or CPI remains on target to print above 2% and more institutions within Japan begin to see the diminishing returns of buying JGBs and begin to buy foreign stocks like those in the United States, the JPY could continue to weaken further and the S&P500 could continue its rally. 

The S&P 500 Correlation to the USDJPY

Since the end of 2013, the USDJPY has closely tracked the S&P 500 which is a favored index among those who trade and follow stocks because the S&P 500 is a broader index than the Dow Jones Industrial Index which covers only 30 US based conglomerates. However, you'll see in the 2nd attached chart that since December 2013, the USDJPY is said to have a significant correlation to the S&P500 with a correlation coefficient currently at 0.777 (whereas 1.00 is a perfect positive correlation). Therefore, if the USDJPY is able to march to the top of the channel on the first chart or possibly break the falling channel, you could easily see the S&P500 continue to the 2000 point level that many Wall Street Analysts are now targeting for 2014. 

Ways to Play the USDJPY If JPY Weakness Continues

Favorable JPY Crosses in 2014 should the trend continue: USDJPY, EURJPY, GBPJPY & NZDJPY based on the technical resilience of the New Zealand Dollar and the Reserve Bank of New Zealand's outlook which is bullish for the New Zealand Dollar over the next few years. 

Happy Trading!

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