From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley
The Japanese yen continues to be front and center, as the safe-haven currency can't seem to find its footing.
In a market where risk assets are struggling to catch any sort of sustained bid, finding investment opportunities in yen has been a great strategy. It continues to work.
Long USD/JPY has been one of the best trades on the sheets this year – by far! And it looks to be continuing its upward trajectory, as it hit fresh 20-year highs earlier this week.
Aside from providing a stellar trading opportunity, the current intermarket relationship between this forex cross and the bond market may reveal the near-term direction of the US 10-year yield.
Let’s take a look.
Here’s an overlay chart of the USD/JPY pair and the US 10-year yield with a 26-day correlation study in the lower pane:
These two charts have followed similar paths during the past 12 months, and their relationship has only grown stronger recently. This is illustrated by the consistently positive correlation coefficient in the lower pane.
Interestingly, this strong relationship all centers around the Bank of Japan's effort to put a cap on domestic interest rates.
They’re accomplishing this by purchasing Japanese government bonds in the open market. To do this, the BOJ has been reducing its US Treasury purchases.
This chain reaction is putting upward pressure on the US 10-year yield.
After some corrective action, both charts found support last month and kicked off fresh legs higher. In the weeks since, USD/JPY has been breaking to new highs while the 10-year is yet to take out its May high.
If the current relationship holds between these two markets, it stands to reason that the US benchmark rate is headed higher as well – most likely sooner than later.
Intermarket relationships come and go due to the markets' constant flux. The positive correlation between the USD/JPY and the 10-year yield could easily break down and is unlikely to remain as strong as it's been over longer time frames.
But that’s not the situation today.
Right now, this relationship is as tight as it gets. The yen is giving us great information about the direction of rates and we're going to use it to our advantage as long as it remains the case.
For now, that information is telling us the strong advance in USD/JPY suggests we're likely to see higher rates in the near future.
Countdown to FOMC
The market is pricing in a 50-basis-point hike at the June meeting next week.
Here are the target rate probabilities based on fed funds futures:
*Click table to enlarge view
This data is from the CME FedWatch Tool as of June 9, 2022.
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