Yen Carry Trade Unwind May Spark Higher Stock Market Volatility
The recent jobs report in the US seems to have had little impact on the market's volatility, despite expectations of nervousness. The dollar index rose to 10.9 on the day, suggesting that the unemployment rate may actually fall due to people retiring from the labor force rather than job losses.
However, a closer look at the yen carry trade indicates that a stronger yen could lead to higher stock market volatility. The USD/JPY pair fell by 1.85% as traders increased their bets on a BOJ rate hike, which could ultimately lead to an inversion of the historically negative correlation between the two.
Historical data shows that the low in implied correlation has marked the top in the dollar-yen relationship twice before, with the last instance being in 2024. The 60-day rolling correlation indicates a strong relationship between the two, and if this persists, a stronger yen could lead to higher index volatility.
A similar pattern is observed in other yen FX pairs, such as AUD/JPY, which has fallen from 109 to 90 in the past. If the current trend continues, it's likely that the relationship will invert again, and the BOJ may use this as an excuse to pause its rate-hiking cycle.