Is the yen-Nikkei correlations breaking down?
Over the recent past, or from a year to date basis, yen and the Nikkei has had what seems as a ‘tight’ inverse correlations, where falling yen coincided with a rising Nikkei and vice versa.
Such relations appears to have even tightened during the post Kuroda’s doubling of monetary base announcement last April.
The green vertical lines illustrated above has shown almost precise inflection points between the yen-Nikkei.
Ironically since the 2nd week of July such phenomenon appears to be breaking down where the Nikkei seems on an upside trek along the yen.
In short, over the interim, from negative correlations to positive correlations.
Has this been an anomaly? Or has the Yen-Nikkei’s broken negative correlations signify a start of a new dynamic?
And what appears to be an influence behind the scene has been the Japanese Government Bonds (JGB).
Ironically in contrast to the actions of her western counterparts, yields of 10 year JGBs have been falling.
As of this writing, 10 year JGBs are at a 3-month low.
Chart from investing.com
And this comes even as Japan’s inflation rate has reportedly jumped by .2% (chart from tradingeconomics.com)
The reality is that the inflation data has been skewed.
Even as Japan’s monetary base has reached a record high in July, up 41% year on year (Japan News), the gist of price inflation has concentrated on energy and transportation related industries, according to data from the Ministry of Internal Affairs. The rest of the industries has shown little evidence of mounting price inflation.
This means that Japan's financial markets may have been pricing in lesser expectations of a revival of price inflation in JGBs and thus firming yen.
Rising stocks has partly been bolstered via conveyance of political support through media. For instance, the incumbent administration continues to exert pressure on the largest public pension fund or Japan's Government Pension Investment Fund (GPIF) to shift her resources to the stock markets (Chicago Tribune).
Governments raiding of savings via pensions-social security has become a global trend.
A bigger factor has been the boom bust cycles that has plagued Japan’s financial markets. The near daily rollercoaster swings of the Nikkei has been evident of such dynamic.
This only shows how JGBs are in a trap.
If price inflation fails to take off, then higher real rates would mean the amplification of the cost of servicing Japan’s colossal, and still growing, debt load.
And should her domestic boom bust cycle weigh on the real economy, diminished revenues will magnify on her deficits thus even putting more strains on unsustainable Japan’s debt levels.
When the investors begin to question on the ability of Japan’s government to service her debts, this will be reflected on JGBs.
Even considering the recent decline, Japan’s credit default swaps remains elevated (Tokyo Stock Exchange). This means Japan’s credit risks remains relative higher today than from the first quarter of the year.
On the other hand, if price inflation does take off, then expect JGBs to rise in correspondence.
For now, Abenomics has mixed up or has vastly distorted the relationships of her markets.
JGBs appear as in a transition equivalent to the proverbial calm before the storm.
Meanwhile the changing relationship between the yen-Nikkei seems as a manifestation of the monumental struggle between inflationary and deflationary forces or the boom bust cycle in Japan’s financial and economic system.
Interesting developments.
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