The recent high correlation between the USD/JPY and the S&P 500

On Friday afternoon 1/9/15 I was staring at 5 minute charts of two of the most highly traded markets in the world and became aware of just how interconnected they had become. Below is the charted percentage change of the USD/JPY and the S&P 500 (SPY) on a 5 minute time frame. Percentage returns are used since it allows for a convenient graphical comparison.

1-9-15 USD/JPY in blue and SPY in orange

The two markets maintained a .59 correlation coefficient for the hours the S&P 500 remained open on Friday 1/9/15, calculated on 5 minute returns. While observing the chart keep in mind the SPY (orange line) is going to have more exaggerated movements than the currency pair USD/JPY (blue line) since currencies typically move in much smaller percentage increments than a stock market index.

Let’s pull these two charts a little farther apart and throw in some trend lines to get a better feel for what caught my attention.

1-9-15 USD/JPY in blue and SPY in orange

Above, both markets fell when the S&P opened at 9:30 a.m. EST and then traded in a wedge formation from 10:00 a.m. until 2:55 p.m. when they both temporarily broke to the upside of the wedge.

Below are recent correlation coefficients of the USD/JPY and SPY calculated on 5 minute returns for one day of trading during regular U.S. market hours, 9:30 a.m. to 4. p.m. EST.

Yearly correlation coefficients of the USD/JPY and SPY calculated on daily returns.

As a general rule the U.S dollar will commonly trade inverse to the SPY. A weak U.S. Dollar is good for corporate profits and so is often accompanied by a bullish SPY. Of course, this is not a resolute rule and the USDJPY in particular has often bucked this trend. Here are some longer term charts of the returns of the SPY and USD/JPY plotted together.

The daily chart below starts in mid-2012 and shows the similar trend of the SPY (orange) and USD/JPY (green)

The chart below is on a daily time frame beginning in late October 2014. That huge green candle near the left side of the chart is the USD/JPY reacting to the October, 31 2014 announcement from the Bank of Japan (BoJ) stating it will once again expand its quantitative easing (currency creation) program. This new policy will expand the monetary base by 80 trillion yen ($688 Billion) per year up from the previous policy of 65 trillion yen per year.

The aggressive monetary policy means extremely low interest rates in Japan, which induces traders around the globe to borrow in Yen, convert the Yen into Dollars (pushing USD/JPY up) and then put the Dollars into the U.S. stock market (pushing SPY up). In certain environments the USD/JPY and the SPY’s interrelationship can become so substantial that mean reverting traders attempt to capitalize on the affair. When a divergence develops between the two markets these mean reverting traders expect it to be only temporary and will execute transactions that bet on future convergence. This process often develops into a self-reinforcing feedback loop which serves to further escalate the high correlation between these markets.

I will leave you with charts of trading activity from three other recent days. Charted percentage change of the USD/JPY (blue) and the SPY (orange) on a 5 minute time frame.