GBP/JPY: A Perennial Barometer Of Stock Markets
Ben Robson | Mar 25, 2019 06:44AM ET
Last week,on Wednesday 20 March, the Federal Open Market Committee of the US kept interest rates on hold in a range of 2.25% to 2.5%. Fed Chair Jerome Powell indicated that US interest rates will stay on hold for "some time." It took the markets a couple of days to digest, and then fear gripped US indices on Friday as major stock markets fell in tandem with the US yield curve inverting. There are now several calls for a recession. In previous years, an inverted yield curve has been one of the catalysts for a lengthy down-turn in markets.
The strength in US markets and the trajectory of US interest rates has long been associated with general well-being in many World stock markets. Confident investors can speculate in riskier assets overseas by using what's known as a carry trade. By borrowing an inexpensive currency in terms of interest such as the yen, investors can seek superior returns in the Nikkei for example.
Yen carry trades have long been a barometer of healthy overseas stock markets. In currency markets holding long positions in AUD, NZD, GBP, USD versus JPY have also yielded positive carries. The main issue arises when equity markets lose their fizzle and a flight to quality ensues.In these instances the Yen can quickly gather strength. Extreme examples of this are the market meltdowns of 1998 and 2008 with corresponding huge moves in the Yen. In December 2018, as equity markets corrected we also saw the yen strengthen against a whole host of currencies. As confidence re-emerged in markets in the first quarter of 2019, the yen weakened.
As the two charts show, USD/JPY has a close correlation with the Nikkei.
The British pound has been the subject of intense scrutiny with respect to the ongoing negotiations of BREXIT. Last week, in a tough week for the British Government, Prime Minister Mrs. May had to ask the European Union for more time to try and get her agreement through Parliament. It is still uncertain as to whether the UK will leave the EU with a deal and so the chances of "No-deal" become a real possibility. Most analysts agree that "No-deal" will be negative for the British Pound and so for me, I feel that in the context of falling stock markets, the potential for a strengthening Yen and the UK coming out of Europe with "No-deal" then there is an opportunity to go short GBP/JPY.
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Accordingly I shall be going short GBP/JPY at the level of 145. My target is 132 and my stop is above 151.5, representing a 2:1 reward to risk.
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