In a world where stat arbs do most of the trading, and where central banks set the prices, everything is a correlation of a correlation of a correlation, and as we have not tired of pointing out since 2010, virtually every correlation starts with the USDJPY, the preferred funding vehicles for BOJ intervention in capital markets, as well as an indicator of Japanese pension fund, in most cases the GPIF, activity in the US risk assets.
It is this USDJPY’s anchor that overnight angered SocGen FX strategist Kit Jucker who writes that “the correlation between USD/JPY and US Treasury yields remains stupidly strong.” As expected, the flow-thru starts with the BOJ:
“The causation seems clear enough – the BOJ is anchoring Japanese yields and the relative appeal of the yen is a function of yields overseas, encapsulated by the global bellwether. The last year can be divided into two ranges. Pre-Trump, USD/JPY traded in a 98-108 range and 10s in a 1.3-1.8% range. Since mid-November, USD/JPY has traded in a 108-119 range, 10s in a 2.15-2.70 range. We are at the bottom of that range, in both FX and bond markets.”
What are the implications for these two key asset classes according to the SocGen strategist?
From here, I’d rather be short yen than short Treasuries, but I wouldn’t like to be long either. Is this week’s move caused by the soft US data on Friday 9adn soft Ism prices paid yesterday) or by risk aversion (Comey testimony, UK election, Qatar)? Both play a part, obviously, but the pound’s ignoring the polls, and glancing through equity markets and commodity market moves, there’s no evidence of wider risk aversion. Oil prices have dropped back, partly on the grounds that there are not yet any economic sanctions being imposed on Qatar. I’m more inclined to see this fall in US yields as the last leg of the rally which started when huge bearish positions were squeezed at the end of Q1.
Now that we’ve see a sizeable long position build-up in CFTC data, I’m more inclined to view this latest move as the last hurrah of the bond bulls, and fade it by staying long EUR/JPY and going long USD/JPY.
Juckes’ contrarian bearishness on TSYs is hardly that “contrarian” as many other strategists, Goldman most notably, have been urging to sell any rallies… even as yields have dropped to YTD lows as they did this morning. Now that China has made a firm commitment to buying more US paper, however, as per today’s Bloomberg report, it may be time to reevaluate now that a path to a sub-2% yield appears to have emerged.