The most amazing statistic you never heard, according to Ken Fisher, chief executive of Fisher Investments and Fisher Wealth Management, is the year-to-date daily correlation between ups and downs in the global stock market versus spreads between the yen and the euro: 93 per cent, or “beyond eye-popping”, Fisher notes in the FT’s Insight column on Tuesday.
On days when the euro rises against the yen, stocks rise. On days when the yen rises to the euro, stocks fall. This year’s daily yen/euro changes perfectly track this summer’s stock market correction and subsequent resurrection. Make a chart of stocks, then the yen/euro spread; slip one on top of the other, and they are virtually indistinguishable.
It ‘s all driven by the yen carry trade financing the global bull market. Yet, notes Fisher, “if anything torpedoes this bull market, it will be a rising yen, probably driven by Bank of Japan monetary tightening”.
The same correlation is true, to a slightly lesser extent, for individual country stock markets and the relationship between the yen and other currencies.
The 2007 year-to-date daily correlation coefficient between changes in the yen/euro spread and the MSCI World Index is 0.93. For the S&P 500, it is 0.89, for the FTSE 100, 0.86, and for Germany’s DAX, 0.87. All higher than most people can fathom.
The correlation of the MSCI World to the yen/sterling spread is lower, at 0.75, but is still sky-high. To the Australian dollar it is 0.86 and to the Canadian dollar 0.81. All breathtakingly high. Only to the US dollar, which everyone fears, is it materially lower at 0.37.
What gives?
At Japan’s ultra-cheap interest rates, it makes sense to borrow there rather than where interest rates are higher. People do, from all over the world, selling yen and moving the money to higher-yielding countries to invest, picking up the interest rate spread.
To do so, they must also buy that new currency. The process - the yen carry trade - pushes the yen down and other currencies up. That investors would do this to the extent they can is perfectly rational, notes Fisher. Conventionally we think of it as people borrowing at low rates and lending into high-yielding countries such as the UK where, if sterling does not fall materially relative to the yen, there is a free ride.
The process tends to be somewhat self-fulfilling, as people sell yen and buy high-yielding currencies like sterling, keeping the yen relatively weak.
The correlation between the yen/euro spread is high to major-nation bond prices too. What is shocking, notes Fisher, is that it is now higher still to stocks, and has been so very high, beginning in late 2006.
When short-term money is borrowed in Japan, as elsewhere, that bank loan increases that country’s money supply, and in this case, pours that money directly into capital markets around the world, driving stocks higher.
The BoJ, therefore, is financing the global bull market directly without meaning to. The impact is immediate, and to the stock market, feels great. Most days when there is a big intra-day wiggle, it is mirrored in the yen/euro spread too.
If you like rising stocks, you do not want to see a rising yen. If the BoJ envisions Japan’s economy as adequately strong and suddenly changes policy, increasing interest rates materially – pushing the yen up – it would kill the carry trade.
That would scare those who have already taken carry trade money out of Japan, forcing them to reverse course, unwind their trades, sell stocks, and flood the money back into Japan. In the process, global stocks would suffer, as would the high-yielding countries’ currencies relative to the yen.
With the correlation this high, do not fear a weak dollar; fear a strong yen. Any material sign of BoJ tightening would be very bearish.
