From the Desk of Ian Culley @IanCulley
Let everyone grumble over the Japanese yen.
I get it. The yen was cast as the villain decades ago, and something or someone must take the blame for the VIX hitting 65 earlier this week.
While I prefer to point my finger at the preceding low-volatility environment, the November election, and potential rate cuts, the yen certainly played a part.
But the real question isn’t who, what, when, where, or why.
Instead, every investor wants to know…Was that it?
Is the selloff over?
I think the worst is behind us.
Here’s why…
Check out the USD/JPY chart with a 200-day simple moving average in bright blue (with the percentage above or below the long-term average in the lower pane):
In many ways the yen carry trade is a play on interest rates.
Notice the USD/JPY rocketed higher as the current hiking cycle began, rising with the widening spread between the Japan and US overnight rates. Powell’s war on inflation and Japan’s Yield Curve Control policies formed a perfect storm for a dollar-yen rally.
But by October 2022, the forex pair reached a thirty-year high – 15 percent above the 200-day moving average.
Talk about a face ripper!
The crumbling currency forced the Japan Ministry of Finance’s (MOF) hand to buy yen in the open market.
The MOF intervention – and this is the key – spooked the market.
Fear spurred a ferocious unwind, driving the USD/JPY well below its long-term average – to levels not seen since 2018, the 2020 COVID selloff, and Monday.
Elevated risks are jolting markets from their low-volatility rally – a potential economic slowdown, the November presidential election, rate cuts, war…pick your poison.
On the bright side, price tends to mean-revert after reaching extreme levels. We’re witnessing such a bounce in the USD/JPY and risk assets as we enter the back half of the week.
I doubt stocks will carve out a V-bottom correction, but the major averages may be near the low.
Let’s use 2018 as an analog; Powell turned dovish, investors unwound their yen carry trade, and markets rallied following the first rate cut. How the market reacted following the initial volatility shock and the eventual policy shift may prove salient.
The S&P 500 bottomed in early February, while the USD/JPY reached a cyclical low six weeks later.
The talking heads may be right – the yen unwind might not be over yet. But more downside for the dollar-yen doesn’t necessarily equate to fresh lows or a twenty percent correction for the indexes.
I doubt we’ll see the VIX at 65 soon, but volatility is likely here to stay. The difference in bar size between the 2017 and 2018 rallies tells the story.
No one likes a selloff. Everyone knows bull market parties are more fun.
As small caps join the party, we should expect a lively stock market rally.
Take solace in that the worst is likely over, and the next leg high for stocks is just around the corner.
–Ian
Thanks for reading.
And be sure to download this week’s Currency Report!
