Email of the day
"The AUD/JPY cross has in the past been a good indicator of risk on/risk of mood and if you look at the cross with a SPX overlay, you can see a tight correlation and a bit of a leash affect. That is up until late 2011 (on weekly basis). I'm curious if you have a theory on this and if the correlation is no longer valid (or SPX overvalued or AUD/JPY cross undervalued - or both)? Thank you"
Eoin Treacy's view Thank you for this informative email which is sure to be of interest to the Collective. The yen was the carry trade currency of choice for much of the last decade as ultra-low interest rates coupled with its relative weakness allowed speculators to earn significant returns. For as long as that remained the case, various Yen cross rates with higher yielding currencies had a high degree of correlation with many equity indices.
Following the credit crisis crash, the number of countries with ultra-low interest rates and weak currencies multiplied and offered more choices for leveraged traders to source capital. The strength of the Yen over the same period has acted as a deterrent to carry traders. Over the last few years, both the Dollar and Euro have been more suitable carry trade funding currencies. This may help to explain the breakdown in the correlation you mention. This also acts as an example of how correlations work for a while but eventually deteriorate.