Dow Jones Falls 241 points. What does it mean for USD/JPY?

[DailyFx]

The U.S. stock market fell sharply on Monday on renewed concerns over the health of several financial firms. Yet, despite the strong correlation between stocks and carry, we expect USD/JPY to rally further on interest rate differentials.





U.S. Stock Markets Fall on Concern over the Health of Financial Firms

The U.S. dollar had a mixed performance on Monday during a trading session with very low liquidity since London financial markets were closed for a public holiday. The greenback was particularly strong against commodity currencies like the New Zealand dollar but continued to lose ground against low yielding currencies like the Japanese yen. Indeed, the USD/JPY was quoted at 109.33 yen on Monday from 109.85 on Friday. To some extent, the U.S. dollar recovered from earlier losses after a surprisingly strong report on home sales. According to the National Association of Realtors sales of existing homes in the U.S. rose by 3.1 percent in July, the highest level in more than six months. Yet, today’s financial media headlines were dominated by the U.S. stock market which fell sharply on Monday on renewed concerns over the health of several financial firms. For instance, shares of Lehman Brothers fell nearly 6 percent on Monday after Jun Kwang Woo, a top South Korean regulator, expressed concern about Korea Development Bank's interest in buying the investment bank.

The correlation between the U.S. stock market and the USD/JPY is not what it used to be



Despite the historical links between stocks and carry, the correlation between the Dow Jones Industrial Average and the USDJPY is not what it used to be. In fact, the correlation seems to have broken down in June 2008 and I expect dollar strength going forward regardless of the short term performance of the U.S. stock market. Indeed, the Japanese yen could be particularly vulnerable against the U.S. dollar on interest rate differentials. In August, the Bank of Japan left its key interest rate unchanged at 0.5% but downgraded its view of the Japanese economy. On the other hand, we expect the Federal Reserve to increase rates by almost 75 bps in the next 12 months in order to keep up with inflation. In addition, a significant U.S. dollar undervaluation is now likely to lead to a substantial improvement of the U.S. Balance of Payments through continued strong export performance and propel USD/JPY to 120.






Written by Antonio Sousa, Chief Strategist
Questions? Comments? E-mail: asousa@fxcm.com



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