Buy USD/JPY on rising Treasury yields

Author: Adam Button | Category: News

When the world is improving, the most straight-forward trade is to buy USD/JPY.

So far, 2012 has been a good-news year. US economic data has roundly beat expectations, including signs of life in the jobs market. The European crisis isn’t over but it’s no longer getting worse and some sentiment surveys (they’re leading indicators) are turning up. China continues to hum along.

For the most part, markets are reflecting this. Stocks are ripping with the S&P 500 at the highest since July and the Nasdaq at the highest since the tech bust. Commodities and industrial metals are climbing with copper up almost 12% year-to-date. Italian 10-year year yields have fallen from 7.5% to 5.5% and the euro is higher.

One place that is not reflecting that optimism is USD/JPY. The pair is flat on the year even with the Bank of Japan buying the pair in the shadows.

The reason USD/JPY remains near a record low is because US Treasury yields are near record lows. Money moves across borders in search of better yields and with US 2-year notes paying just 0.25%, there’s no incentive to move money to America.

Treasury yields and USD/JPY have moved in tandem for the past three years. Dollar-yen (red) 10s (blue) 5s (green) 2s (purple)

Earlier this year, Treasury yields were showing signs of buoyancy but Bernanke hinted at further stimulus at the Jan. 25 FOMC. At the time, this was widely seen as a hint at QE3 but could also mean some type of verbal/target intervention.

With the potential for Fed buying, no one wants to sell.

But since the FOMC, US data has been upbeat. And in two appearances over the past week, Bernanke hasn’t hinted at further measures.

Another month of upbeat US economic data will put QE3 on the back burner. At that point, everything will align for USD/JPY longs.

The other side of the equation is Japan, where the economy is battered. The Bank of Japan has unveiled a foreign takeover financing program and intervention threats have likely put in a bottom at 75.30.

How high can USD/JPY go?

For starters, when yields were at 3% or higher last year, USD/JPY traded around 82.50 – 600 pips above the current level.

Technically, there is also room for optimism. The 200-day moving average rest slightly above 78.00. Even if USD/JPY stays flat, it will cross above the average in April or May.

Yields still have some ground to cover before a breakout but watch 0.32% in 2s and 2.15% in 10s.