Talking Points:
- USD/JPY has been trending lower alongside drop in Nikkei 225
- Yen's anti-risk trading dynamics reflect unwinding of carry trades
- Retail positioning can help time resumption of USD/JPY uptrend
The Yen has been trading inversely of stock prices, with USD/JPY tracking lower alongside a drop in Japan's benchmark Nikkei 225 equities index. The relationship is built on the currency's long-standing role as a funding instrument for so-called "carry trades".
Most of the time, investors' principal objective is to maximize profits. In FX markets, this is reflected in a preference for higher-yielding currencies - i.e. those corresponding to central banks with higher benchmark borrowing costs - over lower-yielding ones. The "carry trade" strategy takes this logic further: traders borrow at virtually zero in currencies like the Yen to buy high-beta alternatives, thereby extracting the yield differential as income.
When risk appetite around the markets sours however, the markets' focus turns to capital preservation rather than profit maximization and traders cash out of riskier trades in favor of havens. For the FX markets, this means an unwinding of short-JPY carry trades, accounding the currency's inverse relationship with share prices.
Large speculators' positioning in Yen futures illustrates this dynamic, but retail traders' exposure can help confirm turning points in the exchange rate. The DailyFX SSI indicator is a useful contrarian tool that can help identify when the latest sentiment-driven USD/JPY drop has run its course and the next leg of the long-term advance is beginning.
--- Created by Ilya Spivak, Currency Strategist for DailyFX.com
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