The carry trade is signaling potential trouble for stocks

The AUD/JPY has always been a great correlation for the US equity market. The very popular “Carry Trade” has always been a great way to see strong correlation between stocks and the Forex market. Typically, the carry trade is a popular trade (for individuals or institutions looking to capture the difference in yield) in a rising market, but when risk aversion picks up (unwillingness to own assets) the carry trade tends to unwind and they fall precipitously.

Some traders or economists would argue that with so many central banks yielding such low rates, the carry trade is not as popular anymore. However, I disagree. If we are in a world where everyone is seeking yield, no matter how small. I think there is a good amount of money hiding out in carry trades these days. A great example is the AUD/JPY where the RBA has rates at 2.25% and the BOJ who is at .10%.

The first chart I would like to look at is the AUD/JPY weekly chart, which as you can see below, is approaching some critical trend line support. Also, please note we have made a “lower high” in 2014 vs the high in 2013:

carry trade

Next is the SPX (yellow line) and the AUD/JPY:

Carry Trade

If you notice back in 2012 the AUD/JPY rallied sharply, that was when PM Abe was elected and implemented his three arrow approach of fiscal stimulus to the economy, dubbed “Abenomics.” That created a divergence between the SPX and the AUD/JPY (Nikkei followed a lot closer to the AUD/JPY at that time).

If you closely at the AUD/JPY now, we are developing a bear flag formation, which has targets set (technical) much lower. The question that one who owns stocks at current levels will be “will the SPX follow the AUD/JPY if it falls?”

carry trade

The last couple days the AUD/JPY has been pointed lower, even when the stock market rallied 1.5% yesterday. Tonight we have Chinese Manufacturing PMI’s which could affect the AUD/JPY in the very near term.

Disclaimer: I do own JPY, and have been long JPY against many currencies for many weeks including the AUD/JPY.

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The carry trade is signaling potential trouble for stocks

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