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Exploring Correlations Between the Yen and Nikkei

SGX has released an article looking at whether the long-standing assumption that the Japanese yen is inversely correlated with Japanese equity indices, and what this means against the current geopolitical outlook.

Conventional wisdom maintains that that a weakening yen leads to stock gains, with benchmarks such as the Nikkei 225 and the Topix Index strengthening as a result.

According to the data presented by SGX, although the correlation between the Nikkei 225 Index and the Japanese yen fluctuates daily, historical evidence over the past four years shows that the inverse correlation theory holds true most of the time. 

According to data from Bloomberg, as the spot JPY appreciates versus the USD, the Nikkei 225 Index falls, and vice versa.  

But SGX shows that not all Japanese equity indices are equally intertwined with the yen. Over an extended period, average historical correlation between the yen and Nikkei 225 Index is observed to be skewed higher than the correlation between the yen and the Topix Index.  

Looking at a histogram of the average 20-day daily correlation per annum between the yen and the two Japan equity indices, SGX shows that from January 1, 2017, to April 27, 2017, the average correlation between the yen and Nikkei 225 Index was 3.9% higher than the average correlation between the yen and the Topix Index. 

“Taking this analysis a step further, this intertwined relationship is studied with a simple linear regression with the objective of determining how much of the Nikkei 225 Index can be explained by the Japanese spot yen. 

“Analysing data between January 2013 and April 2017, the regression derives the equation Y = 232.2X – 8729.31, where Y (the dependent variable) is the daily Nikkei 225 Index Close and X (independent variable) is the Bloomberg FX Spot JPY Rate at 3:30pm Tokyo time.

“The regression model observes that the Japanese spot yen movement explains 83% of the variability of the Nikkei 225 Index. Furthermore, the model predicts that a one-yen depreciation in the Japanese spot yen versus the US dollar will lead to a 232 index point gain in the Nikkei 225 Index,” says SGX in its research.

The exchange then goes on to note that multiple geopolitical risks, such as the ongoing Brexit negotiations, the French presidential election and continued political tension surrounding North Korea, have reduced risk appetite.

“Due to the perception of the Japanese yen as a safe haven currency, investors tend to gravitate towards the Japanese yen during times of risk aversion, causing the currency to appreciate,” notes SGX.

Although the article doesn’t spell it out explicitly, the general message appears to be that, yes, Japanese equities do tend to have an inverse correlation to the yen, and that right now there are a number of geopolitical concerns that could cause investors to pile into the Japanese currency as they look for a safe haven. 

This would cause the currency to appreciate, which in turn would statistically increase the odds of Japanese equities indices, in particular the Nikkei 225 Index, beginning to weaken.

Galen Stops

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