The Turn in Pound Yen?

From time to time, I like to review various currency movements across the globe to see if a message can be gleaned about the future. For example, if I see the dollar has bottomed or topped, stock markets will adjust based on the loss in profits a strong dollar brings or the increase in profits that a weak dollar brings. With the Euro going into free fall earlier this year (and having since turned higher), the currency markets have been influx and the result has been a very volatile equity market. So as I was reviewing the charts last night, I came across the once quiet currency cross; Pound/Yen (GBP/JPY). I say quiet because years ago I had a client ask me about the cross and my answer was that it was a tough one to gauge because it was a thin market (at the time) and thus risk of loss relative to the limited upside (at the time) made a trade in the currency somewhat of a challenge. Today, in looking at the movement over the past 15 years, this gauge is all about trend.

In looking at the chart attached, a few major things stick out to me. First this ratio has a funny way of leading stock market moves. When the Pound Yen cross peaks or troughs, stock markets tend to peak or trough - essentially reverse the movement of the intermediate trend its currently resides. For example, the peaks and trough in 1998 and 2000 were followed by immediate downside in the S&P 500 and in the latter a bear market. The peak in 2007 in the ratio was followed by an eventual market turn in equities later that year. The low so far in this ratio happened to coincide with the low in the S&P and the correction in stocks has followed this ratio lower - only to see a turn in the currency cross which if correlation follows, means stock markets have bottomed for the intermediate term.

On the rate side, the action seems to be equally muddled as previously a peak in the cross would imply rates moving upward in the US and a trough leading to the opposite. However, this cross peaked with stocks in 2007 and rates fell lower. When it troughed in the spring of 2009, rates came off their lows but not by any major amount. Interestingly, this looks like it could be related to the Yen as the Yen has followed this peak and trough story very well moving down when the cross rallies (GBP gaining on the XJY) and moving upward when the cross troughs. That held for the most part till the spring of 2009 when the Yen should have reversed course and started a multiyear downtrend - instead it has done the opposite which lines up with the Yen.

So the question is this; do stock markets explode to the upside as the Yen and 10 year follow historic norms? The low at this point for the cross is in and that would imply that the correlations that came off that low continue. However, 2 of the variables are "holding back" from following that trend. Perhaps it is as simple as this; if the Yen reverses course and moves lower, we see the stock markets reaccelerate to the upside and rates move upward domestically (and probably globally). One early indication of this is the current doji in the Yen cross - generally speaking a doji one month followed by a large candle the opposite way the next month argues that a high or low is in. Thus the change in direction could come next month.

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