We have a quick question from Sukraj, who asks why the USDJPY is correlated with the US 10-Year bond yields? Thanks for the question Sukraj.
So, to answer the questions, the very first thing to note is that the correlation between the USDJPY and the US10Y is just like any other correlation, which means it’s fluid which means that the strength of the correlation will change from time to time based on different economic circumstances, and if you take a look at the charts and overlay the US10Y with the USDJPY you’ll see there are plenty of times when other factors were more important to the USDJPY than just the US10Y.
And that is because like any other correlation it’s not perfect, and also keep in mind that just because something is correlated doesn’t mean the one causes the other to move, sometimes they do but it can also be due to other external factors that might be affecting the two assets as well, whether the same or not.
Now, the correlation between the USDJPY and the US10Y mostly comes down to the interest rate differential between the US and Japan, or the US10Y and the JP10Y, or otherwise known as the bond spread. So, it’s not just looking at the US10Y, it’s actually looking at the spread between the two yields.
Remember that in Japan their interest rates are in negative territory, and apart from that, the BOJ has yield curve control which aims to keep the yields very low. The BOJ sets its short-term rate target at -0.1% and for 10-year government bond yields they have a target at around 0%. So, in other words, because rates and yields are expected to go anywhere soon in Japan, you only need to really look at the US10Y to see where the rate differentials are going.
So, with Japanese rates in negative territory and yields not allowed to rise, a key factor to kee in mind for the USDJPY and US10Y is carry attractiveness. If there are expectations that bond yields are going to rise in the US due to economic growth and inflation expectations rising, that means that the expectations for higher rates are not based on the central bank raising rates very soon, it’s based on the view of the economy recovering and based on where future policy is eventually headed.
When that happens, and markets thinks US rates are moving higher then there is a carry advantage to use the JPY as a funding currency and buy the US Dollar against it. Once again, the reason why the JPY is attractive as a funding currency is because the interest rates are negative and more importantly the BOJ keeps the Japanese bond yields low with yield curve control.
So, when the market thinks that the worst is behind them and start looking for higher yielding assets, they will look to sell their safe havens like treasuries and that of course causes bond yields to rise. When that happens, the US Dollar becomes more attractive than the JPY since rates in Japan aren’t expected to go anywhere.
However, when you look at this correlation, it’s important, like we mentioned, to keep the current market climate and circumstances in mind. As you know, the Dollar is also considered as a safe haven, especially during times of immense market uncertainty. So, as an investor that needs to rotate into safe havens, would you rather do so in a currency or with bonds that gives you a higher yield or a lower yield? Of course the higher yield, especially if it’s the reserve currency of the world, so my point is that the correlation can and will change in importance and in strength based on where we are in the economic cycle and interest rate regimes.
So, hope that helps Sukraj, as always, any other questions don’t hesitate to let us know.