Here Is Why Japan Equities Are Surging As U.S. Equities Struggle
S&P500 is actually “the yen trade,” not NKY225. A deep-drive, cross-asset market analysis contrary to consensus narratives.
Back in my days as an institutional monkey, whenever the market (Japan equities) would make a significant move on the day, and people across Tokyo’s trading floors had no idea why, you would inevitably hear “uh.. markets up because.. weak yen.” (Or “down because strong yen..”) - that “NKY ↔︎ USDJPY” tie-in was a pretty good indicator that the broader institutional sell-side and financial media has no idea what the hell they’re talking about for that particular day.
Quite literally so - as not only was pointing to “the yen” an admission of “I have nothing of actual substance to add here” - but they’d still say it when USDJPY and NKY weren’t even directionally aligned on the day.
Seems that in 2024, little has changed.
NKY225 index closes +2% on the day TOPIX index +1.3%, and the rest of the region (and the world for that matter) in the red - or flat. Japan, the global standout:
…coming off an overnight U.S session that was by and large down (again)
…and Europe now also down at open
Here are some of the headlines on Japan equity strength as of market close today:
Earnings expectations. BOJ expectations. At least Bloomberg is neutrally just stating facts without trying to force an explanation- and given these fractured headlines suggesting the absence of a clear go-to explanation for what’s moving the market, we can therefore expect a bunch of the following to inevitably come out as well:
The ol’ “JPY ↓, therefore NKY ↑” - here’s a very simple chart of USDJPY and NKY futures:
Please look at the above and tell me where the clear and consistent positive correlation between USDJPY and NKY exists - one that would explain NKY breaking out to 3 ½ decade highs, while USDJPY isn’t even at its year-to-date highs (and mind you, it’s only January 10th, or 4 trading days into 2024 for Japan’s “YTD”).
And I have to believe that the “NKY = USDJPY” people also know themselves that it’s nonsense, but simply have to put SOMEthing out.
So, now that I’ve wasted enough time blasting nonsense trading floor chatter, or what my dear friend Emma Muhleman would appropriately label as “hogwash” - lets discuss what’s going on in green and red blinking tickers, across regions and asset classes.
I will not only explain NKY strength of late, but also SPX’s sudden mid-December rally, and subsequent bad start to 2024 in the process - as at this juncture, NKY and SPX price action are directionally intertwined with one another, and JPY-driven.
And so, let me reiterate the following:
It’s not the NKY that’s currently driven by JPY, it’s SPX.
Furthermore, it’s JPY STRENGTH → SPX STRENGTH, and JPY WEAKNESS → SPX WEAK.
Here’s the chart:
Again, in context of the recent SPX sudden and “mysterious” December 2023 rally, as well as the bad start to 2024 - SPX is a/the JPY trade. At least it is far more so than (long) NKY being a (short) JPY trade-
In fact, SPX has been a JPY directional trade on-and-off for nearly two years.
How and why is “long JPY / long SPX” a correlated relationship?
The basic fundamental reason is- since the Fed started their rate hiking cycle over the past 2 years, short JPY was essentially a hawkish Fed bet, assuming BOJ remains standstill - as US-Japan policy divergence would widen, and US-Japan yield spreads would widen, thereby USD would strengthen vs JPY, or- short JPY on a hawkish Fed and dovish BOJ. And a hawkish Fed is also a short SPX / risk assets trade. So therefore, the opposite could apply - dovish Fed vs standstill BOJ: long JPY and long SPX.
But it also comes down to cross-asset relative pairs.
USD/JPY → JGB/UST & NKY/SPX
Among the major asset classes (equities, fixed income, currencies, commodities, crypto) - currencies are the only ones which are fundamentally structured as pure pair trades. Unlike shares of AAPL or crude oil futures or US Treasury bonds - when it comes to currencies, you cannot buy JUST the Aussie dollar, or sell JUST euros standalone. In FX, for every Buy, there’s a Sell leg and vice versa. Long USD/JPY means buying USD and selling JPY. Shorting GBP/EUR means selling GBP to buy EUR.
Over the past several years, I have been applying this basic long/short pairing framework (relative ratios) to the other major asset classes and their respective regional US / Japan futures markets- bonds (USTs / JGBs) and stocks (SPX / NKY225), and then compared these long/short ratios to USDJPY (which is a USD / JPY ratio) on a shared percent-for-percent chart. And currently, these US / Japan cross-asset ratios are as closely correlated as they’ve been in this global post-easing era.
Cross asset - these US/Japan ratios are remarkably in-line with one another in terms of performance - and not just directionally, but the percentage magnitude of their respective moves. Percent-for-percent.
This is interesting on many fronts - and no, the tightly correlated pair movements cross-asset is not at all “how things always are/have been” by any means. Sometimes they align for a period of time, most times they do not, and currently they’re tightly aligned across all three asset classes more than they have going back for years. What this allows for is to provide an easier side by side cross asset comparison to try and determine what market leads (or trails) what - and if not, at least what is moving (with) what.
Of the three ratio pairs, the directional matchup of the JGBs/USTs ratio vs USD/JPY makes the most fundamental sense- given that price action on major spot currency pairs like USDJPY are often based on nominal yield spreads between sovereign bonds (US yields - JGB yield spreads price action ≈ USDJPY exchange rate) - BUT, not always the case. Furthermore, HOW 10Y JGB and UST futures prices are quoted completely differ from one another.
10Y JGB futures prices are quoted in yen on Japan’s OSE/JPX exchange, down to the second decimal point (i.e. “156.04”), whereas 10Y UST futures on CME (ZN) are priced in USD in half-of-1/32nds increments (i.e. “111-19” = “111 19/32”) - they might as well be (and are) completely different languages. But, whatever alien price quoting and tick size system they each use, their respective percentage movements are normalized against one against another all the same.
Now, with that said on bonds - yes, this is a deep-dive market analysis of relative performance within asset classes, and how remarkably correlated these relative performances are ACROSS asset classes. But for the sake of keeping this as an article in length (and not a novel), I will focus more on the equity side in light of NKY breaking out, and SPX struggling after rallying. Since all three asset classes are interrelated, bonds will unavoidably be mentioned going forward - but I will save the specific discussion on JGBs/USTs/bonds for another article.
Ultimately- this is about how SPX’s price action tracks back to market developments stemming from Japan.
With respect to the equities vs JPY, it’s not a “USDJPY = NKY” - which has been an increasingly flimsy and unreliable relationship. Rarther, its the long/short ratio of NKY futures / SPX eminis futures that match up directionally with USD/JPY:
This has actually been the case for years - albeit subject to periodic differing degrees of correlation, but still remarkably moving in tandem:
So, which moves which? Currency pair moves the equity pair? Vice versa? Or neither/nor - and they are independently coincident?
The answer can differ depending on the scenario. For example, in my most recent note Japan Rejoins Global Markets: Watch US Equities as New NISA Launches - I discuss two points on Japan equity markets to be aware of:
1) what is currently happening in the immediate term with NKY / SPX long/short driven by JPY (what this very article is deep diving into), and
2) Japan’s New NISA tax-exempt investment account revamp that launched January 2024, which can potentially unleash trillions in Japanese mattress-cash into equity markets - namely US equities.
On the latter - if there is indeed a significant and ongoing flow of trillions in dormant, mattress-stuffing JPY that is now being deployed into overseas (US) equity markets - that steady and increasing sell JPY flow to buy USD assets in itself could potentially impact USDJPY, and if it does, that would be equities driving FX.
See this guy below fanning the flames- and single handedly boosting MLB player contract inflation:
But that NISA flow is not happening right now (or if it will at all).
What is happening in the immediate are futures-driven long and short equity index futures of SPX eminis and NKY, which are being driven by an extremely jumpy yenterventioned spot FX market, a crowded short JPY futures market, and an erratic options on JPY futures market - which drive the equity market ratios.
Back to the comparative cross asset chart- here are each of the ratios’ respective recent peaks before they decline:
These respective tops are not occurring randomly. I have marked two specific levels for USDJPY: at 150, and at 151.96 - levels which the JGB/UST ratio and NKY/SPX ratio have respectively topped:
What is the significance of USDJPY levels 150 and 151.96?
Those are Japan officials’ yentervention (state directed currency market intervention) related levels.
USDJPY 151.96 is the last yentervention highs from October 2022, which still remains the 3-decade highs as of this writing. And USDJPY 150 is a market-self-imposed “yentervention” assumed level - a level where markets believe that the Japanese government will act to intervene and cap upside on USDJPY, and therefore make the assumed cap a self-fulfilling market reality.
See below- we have a relentless rally in not just USDJPY, but the broader dollar complex (via the DXY index) - a DXY rally that is stopped dead in its tracks, tops, and reverses downwards when USDJPY initially hits the self-perceived 150 level:
What’s more, by looking at US yields that decouple and continue higher after DXY peaks, you can see how “unnatural” this sudden reversal in DXY is, and therefore how it was indeed due to USDJPY and its unique, “unnatural” non-fundamental price behavior- because state intervention, whether actual or priced as if its taking place, is by definition a non-fundamental market.
For more on the topic, as well as specifically USDJPY 150 level, see my previous article on yentervention, and its broad, global, cross-asset effect explained:
USDJPY 151.96
So, USDJPY 150 is where markets self-regulated its upside and muddled around for a few weeks from October to November 2023, then broke through and found its next (and still current) upside resistance at USDJPY 151.96: the October ‘22 yentervention highs.
And for the record- the NKY/SPX ratio peak is right at the BOJ triggering the Nov 1st 12:30PM announcement of an unscheduled JGB buying operation just as JGB yields look to break 1% following October BOJ’s elimination of the explicit YCC upper band, triggering the massive JGB short squeeze rally:
December 7th
December 7th 2023 was a remarkable day for global macro markets - for JGBs, JPY, and NKY - all of which had impact on their US counterparts: USTs, USD and especially SPX.
December 7th was the day that I had pre-flagged the insane JPY move that came hours later (below)
I know I keep quoting myself from this particular day’s notes on the JPY move - but the reason is because it keeps coming back up in relevance. Read the snippets below on my equity market impact commentary - which I obviously didn’t yet know at the time the significance of what JPY’s move just unleashed on SPX and NKY respectively to follow.
Here is from the Dec 7th JPY move:
…that’s USDJPY with a single day trading range from 147 down into the 141 handle, and at one point seeing JPY surging over +2% on $1.4bn notional volume traded within a span of 90 seconds - then whipsawing back down again in a spectacular blow off top.
And THAT is the type of violent volatility can both be caused by, and cause the systematic accounts to trigger automatic liquidations on various other futures positions. For now, it seems that Japan equities were evidently the standout victim.
Though of course it makes sense why, it still is quite unusual to see such isolated behavior among otherwise uniform DM equity indices, particularly in 2023 which had been led by Japan:
JPY’s Dec 7th move itself explained here:
When JPY futures had massively rallied on December 7th, taking USDJPY from 147 down to 141 within a single trading day - that had serious cross-asset positioning impact, triggering forced unwinds and momentum in systematic flows across futures markets. This is what I had also flagged in my latest note Jan 4, 2024: SPX E-minis, NKY futures, and the early-December USDJPY flash crash
Relevant excerpts from the January 4th note below:
Here is a chart of Japan NKY index futures and NDX100 index futures % performance over the past 3 months, scaled together. And as you can see, Japan NKY and US NDX had been moving percent for percent in lockstep throughout, but then suddenly and widely split apart - with NDX at one point trading a net +8% higher to NKY futures - quite a wide gap:
And what else happened that coincided exactly with this sudden year-end breakout surge in NDX to hit intraday all time highs, as well as an initial sharp opposing DROP in NKY?
That freak rally in JPY futures on Dec 7th:
Is it possible that (somehow) systematics were (purposely or not) programmed as a long/short on NDX/NKY futures, which had been triggered to unwind by JPY futures’ hyper volatile rally?
Again, there are no fundamental domino cause-and-effects to try and rationalize NDX / NKY that may or may not even be directly paired as a long/short, nor how a sudden JPY futures rally has to do with this (again, if at all). These end of year thinly traded markets make for systematic futures accounts to have a more outsized influence on price action, and volatility induced, rules based systematic risk position adjustments can occur for any reason, and manifest in any (usually related and liquid futures) market, in any manner.
Read full article from Jan 4th here: SPX E-minis, NKY futures, and the early-December USDJPY flash crash
So, lets take one last look at that long/short NKY/SPX ratio performance, in order to explain NKY and SPX price action themselves.
First, see just how much NDX had suddenly deviated from NKY- clearly abnormal relative to how much of 2023 went, trading percent for percent in tandem (NDX is interchangeable with SPX in this case - US big tech indices vs NKY)
Now lets zoom in and take a closer look, layering cross-asset markets step by step.
Here are SPX Eminis and NKY- trading in-line, then splitting off directionally - and not only that, but almost as closely inverse correlated as they were positively correlated - moving identical, to becoming nearly mirror opposite reflections in price action:
And that kind of correlated (co-related) price action flip can suggest that one is moving simply because the other one that it is paired to/against is moving- such as a sudden SPX rally occurring due to a sudden NKY drop, and really nothing else SPX related.
Before we look into whether or not this is the case, what I can tell you with far more confidence is that the mid-December sudden SPX rally was not “Fed/dovish Powell press conference” incited - as per the near-unanimously accepted narrative.
Did SPX rally on Dec 13th FOMC day? Obviously we all know it did.
Did SPX rally entirely BECAUSE of Dec FOMC? No, it absolutely did not.
SPX Eminis were already trading +2.3% up for 6 days prior to FOMC on Dec 14th, beginning on Dec 7th. Mind you that prior to Dec 7th, SPX was trading lifelessly flat in a 0.8% range for nearly a month, and the VIX falling into the 12-handle for its then-YTD lows.
But on Dec 14th at Japan market open, NKY falls nearly -2% in the AM session as USDJPY breaks into the 140s. So much for the “Santa Powell Rally” - Christmas skipped over Japan in Dec ‘23 it seems.
Dec 7th, JPY makes an intraday +4% move on massive volume due to large outstanding call options on JPY futures going in-the-money just before expiry date.
And as JPY futures rally, so goes SPX Eminis
Note the spike in trading volume on JPY futures throughout the day on Dec 7th in the chart above (circled red).
Compare the above to the same chart of JPY futures vs SPX Eminis, but this time with Eminis trading volume on the lower panel:
Now, this is a bit deceiving - because SPX Eminis on CME did see trading volume jump:
But the reason for the volume is because it happened to coincide with the SPX EMINI Dec’23 - Mar’24 futures roll, before Dec’23 SPX Emini expiry on 12/15:
Furthermore, SPX Eminis volume (and roll activity) kicks off on 12/8, the JPY spike was on 12/7. Perhaps the very fact that SPX Eminis about to kick off quarterly futures roll may thereby make it enter a window of being more susceptible to momentum driven movements, given the split trading activity between two active contracts (Dec’23 and Mar’24 SPX Futures).
Regardless, we clearly we can see which price action and volume leads the other - JPY futures on Dec 7th, SPX Eminis on Dec 8th, and both are well before FOMC on Dec 13th - the supposed “catalyst” that sparked an SPX rally. If you followed JPY price action through December, in hindsight, you were actually given a roadmap for SPX.
And come 2024, when JPY’s listed-derivatives-induced gamma squeeze / short squeeze was short-lived, JPY futures fell - as did the sharply “out-of-line” SPX Eminis back down:
- and by which I don’t mean SPX to come back “…down to Earth” - as something that the aforementioned storyteller talking heads would say, using extremely vague and non-empirical phrasing, while citing the Fed - “SPX got over-excited and priced in the dovish Powell and Fed rate cuts in ‘24 too quickly in December, and now SPX is coming back down to earth..”
Hogwash commentary, zero value contribution.
When I say “SPX to come back down” - I mean back to relative NKY levels that it had deviated apart from on Dec 7th, and close the gap back up.
And if SPX won’t plunge sharply to meet NKY lower (similar to how NKY stabilized after Dec 7th but stayed more or less static, as SPX soared) - then the NKY/SPX gap will close back up by a NKY rally to meet SPX higher.
And this is in large part what we’re seeing take place - futures driven equity markets in Japan:
Full disclosure- I had this trade on, short ES / long NIY (yen denominated CME Nikkei futures). I’m out now, given NKY / SPX ratio is close to reversing all of its sharp losses at the time of this writing- and I was only playing for a reversal on futures. Worked out ok- both ES and NIY happened to have a pretty similar cost basis for a nearly market neutral net long / short (usually I would trade NKY mini futures, as NKY minis liquidity surpassed larger NKY futures, and the notional size allows for more granularity when scaling in/out). Realized loss on short ES -0.15%, realized gain on NIY +3.9%. I also have a pair long DXJ (Japan FX hedged ETF) / short SPY as a similar trade but with an FX hedge element on DXJ - but this is just a minimum size, just for the sake of monitoring (short 1 SPY, long 5 DXJ).
What will stop NKY upside in the immediate term? Sharp SPX upside + sharp JPY upside. Absent those, NKY can potentially continue its outperformance for the immediate term, much like SPX’s December run.
JPY will be the key determinant of any and all of this.
And so, for the moment, literally no other major DM markets “matter” - an in: none are as consistently inconsistent, and uniquely unique as Japan is right now. On major, decisive and uniform days- they all rise and fall as one, with the exception of Japan.
Global equity market snapshot on Dec 7th:
Global equity market snapshot on Jan 10th:
Any semi-serious market practitioner would therefore gravitate their attention to that which is standalone in defying the trend - and why it is doing so, rather than focusing on an arbitrary piece that’s getting indiscriminately swept up amidst the overall trend.
So- if you solely care about SPX or NDX - great. Watch SPX’s relative behavior to NKY, and watch both in context of JPY - all for the sake of pure SPX interests.
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