A Beautiful FX Risk Aversion Trade – If?

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Commentary & Analysis
A Beautiful FX Risk Aversion Trade – If?

Let’s get right to it, I know you are busy enjoying the global economic recovery J…

  1. If stocks do finally breakdown; or at least stage a major “correction”…and
  2. If the tight negative correlation between the Japanese yen and the Japanese stock market continues, i.e. the Nikkei falls in value and the Japanese yen rises in value as global Japanese funds repatriate…and
  3. If Chinese growth continues to sag and milk prices sag along with it…
    …then you have the makings of what I have termed the premiere “risk aversion” trade in FX…

    • Buy Japanese yen
    • Sell the New Zealand dollar or Sell the NZD/JPY cross…

The chart below is for your review. First some key points when viewing the chart:

It appears we have a nice symmetrical five-wave impulse pattern into the recent high in NZD/JPY which I have labeled “5”… The currency cross is breaking down first, i.e. before the S&P; it did that same thing during the credit crunch. During the “credit crunch” the pair declined a whopping 54%…to say that is huge is an understatement. It is all a guess…but it seems reward is skewed to the downside.
NZD/JPY versus S&P 500 Index Daily:

Now, the next chart may be even more interesting for the esoteric types like me among us…it compares the USD/JPY, Nikkei 225 Index, and yield spread between 10-year JGB’s and 10-year US Treasury Weekly…here is what I discern from the chart:

There is a tight correlation between the Japanese stock market and the path of USD/JPY. There is decent correlation between the 10-year spread (JP – JS) and the path of USD/JPY, i.e. as the spread moves increasingly against Japan (becomes increasingly negative as shown on left axis), USD/JPY rises or the Japanese yen weakens, and vice versa. It is extremely difficult to determine which of the variables leads or follows, so as a forecasting tool it is not exactly something to hang your hat upon… But…we can, I think, make the following general statements which may help:

The Nikkei has failed to make a new high along with the S&P 500 and seems to be turning down and could reflect growing sentiment about a fading recovery in Japan… Despite the rally in the US dollar of late, USD/JPY has also failed to make a new high and still seems to be correcting or consolidating it huge move from late 2012; there are still plenty of Japanese yen bears that could capitulate and lead to another sharp corrective leg lower in USD/JPY (higher in JPY-USD futures)… Despite talk of ending taper in the US, the yield spread is moving in favor of Japan at the moment after bottoming in December of last year. And now back to the If…if this trend in the variables continues, and I think there is a decent enough probability to bet they will, then USD/JPY continues to fall and the NZD/JPY trade remains well supported on at least one side of the equation.

And one more chart setup you may find interesting….our daily USD/JPY wave count showing the alternative. I am working off the premise the pattern completes the triangle down to E II—but confidence is moderate as this has been a choppy move…but if we get a real conflagration in stocks, USD/JPY likely goes lower than my target…

In the spirit of full disclosure, Black Swan Forex clients are short NZD/JPY from 87.08 on 8/5/14/.

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Updated from 7/22 adding 7 more closed trades: Here are the last 17 closed trades we recommended in Black Swan Forex; it produced 409 total pips and $4,450 in total profit, assuming you traded just one-lot or regular-sized contract per recommendation: