In view of Alan Ruskin, Macro Strategist at Deutsche Bank, it’s very rare for the Nikkei to lead global equity mkts for very long, so what we are seeing today where the Nikkei is driving global markets is apt to last for days rather than weeks.

Key Quotes

“As for currencies, the more common linkage has been USD/JPY driving the Nikkei (a positive correlation because of the FX implications for Japan export competitiveness, reflation and Japanese foreign profits brought into yen) rather than the Nikkei risk off leading to capital repatriation and a stronger yen that became a very popular causal chain in the early 1990s. Of late, the 1y Nikkei correlation with USD/JPY on a levels basis is a meager 0.21. So which currency on a levels basis has the strongest correlation with the Nikkei over the last year? Bitcoin, if you count it as a currency. The correlation is interesting in so much as it probably says something about the late Nikkei run, attracting a more extreme 'spec' bid.”

“So what does the Nikkei say about the USD? Interestingly, the DXY correl (on a levels basis which inflates the correlation) with the Nikkei over the last 6m has been very close to zero. While I suspect that a very weak correlation is a fair reflection of the Nikkei linkage to broader USD over the long-term, in the short term and current circumstances there is a very real danger that the Nikkei does slide lower, driving a temporary risk off, that helps the USD vs EM and commodity FX.”

“As for the yen, if Nikkei weakness started to impact growth/inflation expectations, and dampen nascent speculation of an end to yield curve targeting, it would play JPY negative. We should be some way off these concerns given how far the Nikkei has climbed recently. Right now it feels like Nikkei risk is pulling USD/JPY down in part via general positioning liquidation not least short JPY/carry. A stronger JPY versus the USD with risk-off is normally reinforced by US yields falling. Very unusually (and possibly the most interesting feature of today's trading) US and most global bond yields are heading up. The USD- JPY yield spread is then providing a modicum of USD/JPY support.”

“IF we continue with Nikkei lower and more global risk appetite negativity, but US yields higher, then the signal for USD/JPY is very mixed, but probably just slightly skewed to USD higher. In any event there are surely easier currency pairs directly related to risk to trade. In an unusual world where equities slip and lead bond yields up as part of a generalized pick-up in equity and bond vol from historically very low levels, long USD/EM, and long USD/commodity FX makes more sense than trying to sort out the multiple somewhat unusual factors driving the JPY.”

“While the unusual bond-equity linkage today could well be a serious warning shot that bond & equity vols have reached their nadir, the causality where equities go down and seem to tug bond yields higher (as distinct from the more usual higher bond yields pulling equities down) probably won't last i.e, should equities go down, global bond yields won't continue going up for long.”