BNY Mellon - The Aerial View: Two Key JPY Crosses

May 9, 2019

One of the key themes that emerged last year was that as the Fed commenced reducing its balance sheet, the market environment began to take on some of the characteristics seen at the major turning points in late 2000 and late 2007.

It was therefore not that surprising when what looked an awful lot like the "put" reemerged in late November. Muted echoes of 2008, however, have begun to emerge in recent weeks from beneath the somewhat anesthetized calm.

These have been apparent again this week as evidence has emerged of a sharp deterioration in the US/China trade talks. Perhaps the clearest indication that China now expects a new round of tariffs on its exports came from an editorial yesterday in The People’s Daily.

It noted that China has “full confidence” to deal with difficulties and challenges that may arise during its trade talks with the US. It added: “What matters most now for China is to stay calm,” and stated" “Don’t underestimate China’s resilience and strategic determination”.

One of the most obvious victims of the souring sentiment since mid-April (much as proved the case back in the summer of 2008) has been the KRW - thanks primarily to its exposure to China.

The net result is that the KRW is now trading at close to the lowest levels seen against the JPY since late 2016 after one of the sharpest (over 6%) 16-day moves seen since that summer.

If South Korea is a perfect example of the slowing China (and arguably global) growth story then it also makes sense that an equally sensitive bellwether such as AUD/JPY should be coming back into focus, particularly given the notable weakening of yield support seen this year.

As a result the yield gap between 2-year Australian and Japanese government bonds now stands at its narrowest since the summer of 1992.

Unsurprisingly, our own iFlow data show very similar patterns of outflows from both currencies since the start of the year. In contrast the JPY has seen modest but sustained inflows emerging since April 22.

Given this it’s worth being reminded of two things. Firstly, while 10-day realized volatility in both pairs has picked up since April 22 it still remains well below the average levels seen over the past five years. In short, the environment remains very quiet.

Secondly, the exit door from the AUD and KRW back into the JPY can often prove narrow. This was highlighted not only by the remarkable price action seen on the first few days of this year but also by how events played out in the summer of 2008, when the AUD dropped about 15% against the JPY between early August and early September, while the KRW fell about 40% overall during the second half of that year.

With this in mind, it might be worth noting that the base of the post-January 7 range for the AUD is found at around current levels while the January peak for the JPY was just below KRW 10.67, a level that has been breached overnight.