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Yen Cross Pair Trading- Trader’s New Rule-book
The post-credit crisis rule book has been re-written, and hopefully now stabilized what is known to be a trip as close to the edge of the precipice as the global financial markets have probably ever been. In the new trading arena there are plenty of nuances to learn, and old habit to kick.
One of the most vaulted terms used from 2005 through to 2008 was the Carry Trade, as in; “Traders unwound the carry trade today”, or “Positive trading saw the carry trade get built into today”. However, the carry trade has become a distant memory, something to be whispered in dark corners, for fear of sounding foolish, and therefore the following question is raised; what has happened to the carry trade and its Jpy/S&P correlation? TheLFB Trade Team has the answer:
Trading The Dragon: The value of the Jpy (Japanese Yen) has strengthened because for the first time in decades it became as cheap to borrow Usd based funds than it was to borrow Jpy based.
Since March 2006 the Bank of Japan overnight interest rate has moved from 0.0% (Fed @ 4.75%), to a peak of 0.5% in September 2008, (Fed @ 2.0%) to the now 0.1% rate (Fed @ 0.0%).
The interest rate differential, (the difference between the Bank of Japan overnight, compared to Fed overnight rate) has always been something that pushed markets to sell the Jpy in risk tolerant trading (long equity environment), and buy Jpy in risk averse trading (long bond environment).
Now that the global economic community has collapsed other major central bank rates towards the similar rate that Japan has, the Jpy can be valued on the strength of growth forecasts, rather than interest rate differentials.
Reducing global interest rates are as close to the Japanese rates as we have seen, and therefore the Carry Trade and Jpy's converse link to equity direction has become a little tenuous, and will remain that way until global interest rates climb, while Japan stays in a stagflationary economic cycle. The Nikkei had underperformed the other major indexes for years; but this is not the case in the near-term.
The value of any Jpy cross pair is determined by the percentage change in USD/JPY and the percentage change in the dollar based major. For example EUR/JPY (132.62) is made up of the value of EUR/USD (1.4590) multiplied by USD/JPY (90.90). 1.4590 x 90.90 = 132.62
Therefore, the USD/JPY valuation determines the overall market value on the Jpy in other cross currencies, and for the first time in a while the Japanese Finance Ministry will be looking to address the strengthening yen, at a time that economic growth in Japan still has many questions to answer.
Cross-Dragon Trading: Jpy cross-pair trading has unique traits that follow the moves in the cross pair's moves against the Usd, as we saw above. The Jpy cross pairs move only as a consequence of the moves in the Usd based majors, and as such the technical reads have to be taken on two pairs; the Jpy cross, and the Usd major.
If USD/JPY does not move then the Jpy crosses will only be able to replicate the major Usd based moves. Jpy trading then becomes volatile, and to some degree pointless. The spreads are higher on Jpy cross pairs, the volatility increases because of the price average leverage across two pairs, and it turns into nothing other than trading CAD/JPY, for example, at 200% increased spreads, increased volatility, and a lack of stability over and above whatever comes with USD/CAD trading, if USD/JPY is not moving.
Usd direction, USD/JPY sentiment, and overall major pair momentum has to be factored in at the time that a Jpy/Cross ticket is placed. The Jpy cross pairs have their own nuances to work with, and their own specifics of times to place around the regional market opens and closes. Blanket yen trading will not be as reliable as choosing the one backed by strong momentum against the Usd.