USD/JPY: Is risk what drives the pair? - BBH

Analysts from Brown Brother Harriman, pointed out that the safe haven asset is the US Treasury market and noted the strong correlation between the USD/JPY pair and the 10-year yield. 

Key Quotes: 

“The conventional narrative is that the yen's strength is being driven by risk. It seems to border on circular logic. If the yen is up, it must be due to investors being averse to risk, and we know investors are averse to risk if the yen rise.”

“We continue to question the narrative which says that in troubled times, the yen is bought as a safe haven. The flow of funds does not bear this out. Foreign investors do not flock to Japanese markets when investors are fearful. Instead, we suggest that the main behavior that changes is Japanese investors themselves. They are unwilling to recycle the current account surplus, which is derived more from its investment income than trade in goods and services.”

“The safe haven asset is the US Treasury market. That has repeatedly been experienced.  Lower US yields weigh on the dollar-yen exchange rate. The correlation (60-day percentage change) between the exchange rate and the US 10-year yield of nearly 0.8, is the upper end of the correlation range since at least 2000. The correlation with the US two-year yield is a little below the 10-year correlation but is also at the upper end of is range.”

“There are several factors weighing on US yields.  Last week was an important blow to psychology.  There were three pieces of disappointing news.  The core PCE deflator eased for the third consecutive month.   Auto sales were weaker than expected and this will weigh on headline retail sales and could be a drag on manufacturing.  The jobs report was tepid, even though other labor market readings like the ADP, weekly jobless claims and the ISM suggest no deterioration in the labor market.

“There is another factor that may be playing a role, though it may be more difficult to turn it into a sound bite or a tweet.  It has to do with efforts the US Treasury is making to circumvent the debt ceiling which was reached in Q1.  The Treasury appears to have shifted its balances from the Fed.  The apparent shortage of dollars last year has been alleviated, at least until the debt ceiling is lifted.  The White House wants the Republican-led Congress to do so before their summer recess at the end of next month.”