Macro Insights/Report: AUDJPY Cyclical Extreme

Everything is beginning to line up

If you have spent any amount of time trading FX, you will know that it is intricately connected to the assets of the respective countries.

We have entered an environment where higher inflation is putting greater constraints on global central banks. Monetary policy differentials have been the primary driver of FX over the past 2 years. However, the balance sheets of countries are dramatically different which means once growth differentials begin to exert greater force, there is likely to be a greater divergence of monetary policy.

In simple terms, some countries have more debt than others and this will make growth shocks worse. In turn, this will cause the respective central banks to deviate from the FED instead of always following their lead.

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AUDJPY

A critical pair to watch in today’s environment is AUDJPY. Below is a chart delineating the momentum regimes of AUDJPY on a weekly basis:

Several key insights:

• First, most people only focus on the dollar and forget that some of the biggest players in global financial markets operate in Japan, Europe, and Australia.

• Second, due to the NIIP and balance sheet make-ups of Japan and Australia, AUDJPY can function as a risk on/risk off currency. However, this is specifically in the context of the stock-bond relationship. Notice the chart below of SPY/TLT overlayed with AUDJPY.

• Third, the main thing you need to be watching is this 98 level in AUDJPY. This carries heightened significance given where we are with global bond yields and G7 central bank pauses. You specifically want to be watching the stock-bond correlation across all major countries with AUDJPY.

  • We are at a cyclical extreme and beginning to consolidate in both global bond yields and AUDJPY. This relationship will be key to monitor moving into the end of the year.

A key dynamic I have noted in my recent FX report is that correlations change when regimes change. There is a reason for the specific FX moves we see as they connect with the stock-bond correlation. However, this is likely to change as the growth and inflation impulses change in 2024.

I am always focusing on how things are changing as opposed to returning to some “artificial normal” (see my article explaining this macro logic: link). When I think about 2024, I think about how different assets will move in both bullish/bearish directions AND specific correlations.

Right now, we remain in a period of time where inflation is the dominant impulse. This impulse is fading but it still remains an important driver in markets. I will be writing a weekly strategy report tomorrow breaking down how I am viewing assets on a shorter time horizon so keep an eye out for that.

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Thanks for reading!