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Three weeks ago we took a look at the resurgent Yen “carry trade.” I noted:
The Yen is often inversely correlated to global risk appetite, in no small part due to the “carry trade,” which essentially encourages arbitrage by borrowing Yen to speculate on other asset classes. Part of what caused such a disconnect in global markets during the 2007-2009 bear, and even at various points since then such as the Flash Crash in 2010, was the rapid unwinding of the Yen carry trade, leaving highly levered large market players trapped in suddenly huge losses.
We know (that) global markets have surged of late. Even during the correction in the U.S. last autumn, China and Japan were exuding relative strength, among other foreign markets. The accompanying weakness in the Yen, especially versus a currency with a direct correlation to risk such as the Euro, solidified the move.
Looking at an updated weekly chart of the Euro/Yen cross, we can see a now-very steep angle of ascent higher. We are likely to see the Euro cool off here for a few weeks. Bulls want to see a high and tight bull flag, while bears are rooting for a complete rollover and giveback of the recent rally.
Given the magnitude of the multi-year breakout, I am inclined to side with the bulls in terms of a likely initial shakeout followed by a tightening bull flag, rather than a full rollover. Nonetheless, the fact remains that a correction of some kind likely imminently awaits. I am still looking at 110 to hold, with 105 needing to be a concrete floor on any sharp sell-off.
Now, extrapolating this out to the U.S. markets, it need not mean a major top is here is stocks. However, it does likely mean that risk appetite becomes much more selective the higher this market pushes without a meaningful consolidation first, in order to tighten up extended charts.
Also, as a reminder of how significant this currency cross has been for global risk appetite, note how well it acted even as the U.S. markets corrected roughly 10% across the board last autumn. That was just one of the signs to not become overly bearish back then.
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