Aussie/yen cross: Is it the canary in the coal mine?

If you have been following the classic carry trade of late you may have noticed the best “risk on” vs. “risk off” indicators available to traders and investors. If not this may help. The Australian Dollar vs. the Japanese Yen has been one of the primary carry trades of the past five to 10 years.

As you probably know, the carry trade involves selling a low yielding currency to finance the purchase of higher yielding currency to make money on interest rate spread. Textbook risks = changes in interest rates and/or central bank interventions.

Right now the Australian 10-year bond yields ~3.35% and the Japanese 10-year yields ~0.74%

Some context

The Japanese just elected a new Prime Minister, Shinzo Abe of the Liberal Democratic Party. Abe held the same position between 2006 and 2007, but left for health reasons . There have been five others to hold the office since Abe departed with the longest tenured being Yoshihiko Noda of the Democratic Party, who held the position for 481 days. Is Japanese job security a thing of the past?

Abe has vowed publicly to force the Bank of Japan to replace it’s slack 1% target for inflation with a binding 2% target and is willing to undertake “unlimited easing” to achieve the goal. To this point, Shinzo makes Charles (The fire-hose) Evans look like an inflation hawk.

Going back to the AUD/JPY indicator, it is interesting to see how risk markets performed in the months following the Aussie/Yen cross trading north of 87.50 and given this history and the fact that the AUD/JPY has recently crossed this threshold again, whether it will be different this time?

The cross traded over 87.50 at a number of “interesting” points for the broad market: Early September of 2008, late April of 2010, late April of 2011 and mid-March 2012 (see chart below).

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