No capital connection

While currencies such as the Canadian dollar (CAD, see “Remember the Forgotten Currency,” Currency Trader, February 2006) appear driven to a large extent by relative capital market flows, the JPY increasingly has ignored these effects in recent years.

Prior to the onset of quantitative easing, the JPY had a modest correlation with the FRR from one to 10 years in the Japanese market and no relationship with the USD FRR from one to 10 years. After quantitative easing began, the JPY FRR remained largely frozen at steep levels while the USD FRR both steepened and flattened at this horizon. The JPY ignored both curves.

The disconnection between the JPY and relative stock index movement is even more pronounced. Prior to the failure of the hedge fund Long Term Capital Management in fall 1998 — an event that triggered a sudden and massive (11 JPY per USD in one night) revaluation of the JPY — the relative performance of the Nikkei 225 to the broad-based Russell 3000 index declined regardless of the JPY’s course. After 1998, and to an extent largely unappreciated by many investors, the Nikkei re coupled with the world’s major stock indices while the JPY remained in a wide trading range between approximately 105 and 125. True, the Nikkei’s 2005 rally occurred while the JPY weakened, but as the opposite relationship of a weakening Nikkei combined with a strengthening JPY never occurred, we cannot posit any causal relationship.