By DailyFX – After the best week for the Japanese yen in 14 months and the worst one for the nations benchmark stock index in… … 8 months, investors who were suffering, looking for additional profits or were just late to the game are now wondering is this a trend that will spill into next week?

By the time the dust settled and the
exchanges closed, every investor the world over was well versed in the play-by-play
details of one of the most volatile weeks for global markets in months. The action
began on Tuesday when the announcement by Chinese officials that they were crackdown
on locals who were investing with money acquired by loans sent the Shanghai
Composite Index on a 9.2 percent plunge. As the world turned, stock investors in all
time zones were bailing out of their positions with panic easily overcoming the
long-complacent bulls that drove major indices to multi-year highs. However, the
fear didnt stop with stocks. All risky assets were put on chopping block with
special attention paid to the seemingly untouchable carry trade. The currency market
was particularly hard hit with hedge fund staples like EURJPY, USDJPY, GBPJPY and
NZDJPY all dropping over 400 points. The most recent wave of yen buying was set off
by a spat of data, which included the first increase in household spending in a
year. Now traders are left to wonder when (if ever) things will go back to normal.
There is still a lot of money behind the placid carry trade and capital loss limits,
margin calls, portfolio revaluations, and risk aversion will continue to weigh on
the yen crosses. On the other hand, any position traders that go long yen will
already have to trade their way out of losses on paid interest; and this will not be
lost on anyone.

Bonds – Japanese 10-Year Government Bonds Futures

JGBs have held resolutely still on every close over the past three sessions even
though the other Japanese markets were experiencing volatility not seen in months.
This is particularly interesting since the unwinding of the carry trade suggests a
lot of capital is flowing into and out of the Japanese money and government bond
market. Despite these flows, the biggest reaction came on Wednesday when 10-year JGB
futures rallied over 45 basis points to 135.44 and almost completely retraced the
move. Brought on by stock traders looking for a harbor for their diminishing
capital, the BoJ outlook quickly reigned in further gains. Going forward, if debt
prices fail to confirm the reverse in the carry trade, it may be a clue that a wave
of borrowing will quickly put an end to the trend.

FX – NZD/JPY

When examining the yens strength, it can be in almost all of its major pairings.
Against the dollar, the yen rallied over 400 points; the euro 505 points; the
Australian dollar 435 points; the British pound a massive 1000 points.
However, despite these impressive moves, no other better defines the carry trade
(and its unwinding) like NZDJPY. Though its four day loses were a mere 530
points, the pair itself was built for the carry. By now, every savvy investor is
aware that the Japanese currencys 0.50 percent benchmark yield is one the lowest
of the top currencies. At the other end of the spectrum, the New Zealand dollar has
a considerable 7.25 percent rate attached to it. Beyond this incredibly high rate,
the kiwi has very little to offer the currency market as it is a very small trade
partner in the global economy. This places a considerable burden on the carry trade
appeal to sustain strength.

Considering this relationship, this currency pair may be the optimal barometer for
measuring the strength and popularity of the carry strategy. When NZDJPY marks its
bottom, it may signal to other pairs that they will no longer receive the unwinding
flows. While the technical scene reveals few reasons to call a bottom (especially
after breaking a 100-day SMA and clearing previous swing lows) the fundamental
current may call the shots. Though the New Zealand economic calendar is almost
empty, the RBNZ rate decision scheduled for Wednesday 20:00 GMT is set to move the
markets. Economists expect the policy group to lift interest rates a quarter point
for the first time in a year as inflation and consumer spending persists under the
already high lending rates. Will currency traders be able to resist an easy 7.00
percent annual return?

Equities – Nikkei 225 Index

Like every other developed nations benchmark stock exchange, the Nikkei 225 Index
has been under incredible pressure in the past week. Up until Wednesday, investors
were steadily bidding Japans top shares to boost the Nikkei to six-and-a-half
year highs. This all changed with the break of a trendline though. The trouble began
on Tuesday when Chinese politicians unnerved its markets with threats of unwonted
regulation. The Japanese stock market acted cautiously so as not to cause a panic.
However, as after European and North American markets plunged as their respective
exchanges opened for trade, calm was the last thing traders back on the island
wanted to be. When the exchange opened on Wednesday, the Nikkei Index gapped as sell
orders flooded the notoriously fragile order routers. As the week wore on, the daily
losses slowed, but the damage was down in a 6.3 percent slide from the high. When
the new week roles around, the Japanese stock market will join the rest of the world
in deciding whether this move is the beginning of the 15, 20, 25 percent corrections
that typically follow such powerful bull runs or if this trip up will just offer
sidelined bulls a good chance to get in cheap. With global markets so well
connected, it is unlikely that Japanese shares will blaze their own path – but more
likely that they will follow the lead of the US and European markets.

Regards,

John Kicklighter
Forex Capital Markets
32 Old Slip, 10th Fl
New York, NY 10005
Email: jkicklighter@dailyfx.com

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