Macro Wrap – All About Japan, $DXJ, $EWJ, $FXY

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The overnight headlines are dominated by Japan’s equity markets’ massive reversal.  Here is the 30 day chart of the Nikkei for a sense of the saying, “escalator up, elevator down”:

30 day intraday of the Nikkei, Courtesy of Bloomberg

30 day intraday of the Nikkei, Courtesy of Bloomberg

I drew the red line to mark where the Nikkei closed, since it’s hard to tell because it fell so hard near the close.  Amazingly, the Nikkei’s move higher has been so strong that it closed right at its 20 day moving average, despite a 10% intraday reversal.  So though the move overnight felt big, most buyers in the last 3 months are still comfortably in the green.

Two things are most notable to me about this price action.  First, it’s very, very rare that you see such a large reversal from a multiyear high in a large equity index (in single stocks, they can happen all the time).  Almost always, moves of this magnitude only occur after a topping process of several weeks or months.  The unprecedented nature of current market positioning is worth noting.

Second, Japan mostly matters because of what its easing program has done for the appetite of risk across the world.  Here is a chart of the USD/JPY currency rate vs. the S&P 500 index over the last year:

USD/JPY cross vs. SPX index, 1 year daily, Courtesy of Bloomberg

USD/JPY cross vs. SPX index, 1 year daily, Courtesy of Bloomberg

I’ve circled in red the period in November when it became clear that Abe was likely to be the new prime minister of Japan, and his new policy of Abenomics was going to be employed.  The yen started to fall (the USD/JPY rate going higher in orange), and the SPX started to move higher (in black), in lockstep with the yen moving lower.

Here was the 3rd largest country in the world introducing a massive new stimulus program, forcing Japanese savings out of Japan and into the rest of the world.  A large portion of that flowed into U.S. stocks, with knock-on effects of forcing other global investors into stocks as well, since missing a substantial stock rally is a major no-no in a world of zero rates.

That leaves us with the current situation, where a large portion of the improved psychology in this market rests on trust in Abenomics working, without nasty, volatile financial market side effects.  A 10% intraday reversal in the stock market is one such nasty side effect.

Central bankers would probably acknowledge in private that the main impact of QE is through psychology.  Psychology is a two-way street though.  It can seem awfully beneficial when animal spirits are running high.  But when greed turns to fear, that same psychological channel, with all of those proposed benefits, turns into a headwind for growth and investment, as investors and businesses hunker down.

I don’t know how the next few months will play out.  But when the 2nd largest equity market in the world goes down 10% on an intraday basis on no news, it’s worth remembering that caution has its purposes too.  For now, I have the USD/JPY rate front and center on my screen.  That’s the world’s risk barometer at the moment, for better or for worse.