Is Dollar/Yen Divergence Predicting Stock Market Plunge?

The Dollar/Yen was under pressure for an eighth session early Friday as safe-haven buyers continued to move money into the Japanese Yen. The Forex pair fell even after hawkish comments from Fed officials nearly solidified a March rate hike by the central bank. This suggests investors are betting on a major sell-off in riskier assets, particularly the stock market.

At 03:38 GMT, the USD/JPY is trading 113.672, down 0.494 or -0.43%. On Thursday, the Invesco CurrencyShares Japanese Yen Trust ETF (FXY) settled at $82.23, up $0.32 or +0.39%.

Most of the time, USD/JPY traders can count on the interest rate differential between U.S. Government bonds and Japanese Government bonds to guide the price action in the Forex pair. However, there are times when safe-haven buying makes the Japanese Yen a more attractive investment than the U.S. Dollar. In my opinion, we’re going through one of the time periods.

The flight-to-safety move into the Japanese Yen could be first sign of fear. The second will be a move into U.S. Treasurys. Finally, demand for the safe-haven U.S. Dollar will be the third sign of impending fear.

The recent divergence between the Dollar/Yen and 10-Year Treasury futures is suggesting to me that investors are taking protection. And I think that protection is against a steep sell-off in the global equity markets.

Just look at the USD/JPY chart and you’ll see that the Forex pair hit a multiyear high at 116.345 on January 4. This was one day before the Fed minutes showed central bankers had turned extremely hawkish. It’s also the day the S&P 500 Index hit an all-time high and the Nasdaq Composite made a top. The Dow Jones Industrial Average reached its all-time high on January 5.

Also on January 4, the benchmark 10-year U.S. Treasury yield closed at 1.66%. On January 10, it rose to over 1.80% before settling at 1.78. Despite the rise in yields, the USD/JPY kept going down. This means that Dollar/Yen investors were shrugging off the rise and yields and putting more emphasis on the falling stock market.

Short-Term Outlook

The USD/JPY continued to weaken on Thursday despite hawkish comments from Fed officials calling for a March rate hike. The news also fueled a sell-off in the stock market and a rise in Treasury futures.

These moves were not from the Economic 101 textbook, suggesting to me that Dollar/Yen investors are hedging against future stock market weakness. I have no other explanation and I’m not buying the chatter that the first Fed rate hike is already priced in.

Stay on your toes because if the USD/JPY trade is predicting what I think it’s predicting then global equity markets are setting up for a steep fall.