The Japanese Yen and Nikkei 225 Index are Consistently Correlated – Fact or Fiction?

• Multiple geopolitical risks have diluted risk appetite. Outcomes that result in greater uncertainty will result in poorer market sentiment and drive investors to safe-haven assets or currencies including the Japanese Yen.

• The Japanese Yen and benchmark Nikkei 225 Index are highly correlated around 70%, and consistently demonstrate a stronger correlation than between the Japanese Yen and TOPIX Index.

• Upcoming events that may affect the Japanese Yen as well as the Nikkei 225 include the final French presidential election polls on 7 May, potential early Italian elections, and a tail-risk event where the North Korean crisis escalates.

Long-standing conventional wisdom has held that the Japanese Yen is inversely correlated with Japanese equity indices, such as the benchmark Nikkei 225 Index and the TOPIX Index. This means a weakening Japanese Yen is typically associated with stock gains. This article studies the interaction between the Japanese currency and equity indices.

Exploring the Relationship Between the Japanese Yen and Japanese Equity Indices

Although the correlation between the Nikkei 225 Index and the Japanese Yen fluctuates daily, historical evidence over the past four years shows that the inverse correlation theory holds true most of the time. As the Spot Japanese Yen appreciates versus the USD (Spot Yen value decreases), the Nikkei 225 Index falls, and vice versa.  Chart 1 below plots the 20-day daily correlation between the Nikkei 225 Index Close and the Spot Japanese Yen Fixing at 3.30pm Tokyo Time.

Chart 1: Daily Correlation Between Nikkei 225 Index Close and Spot Japanese Yen Fixing
at Cash Close (3.30pm Tokyo Time)

Source: Bloomberg, 27 April 2017. Measuring the average annual 20-day correlation of the daily Nikkei Index close with the half-hourly Bloomberg FX Spot JPY Rate at 1530 Tokyo time.

Not all Japanese equity indices are equally intertwined with the Japanese Yen. Over an extended period of time, average historical correlation between the Japanese Yen and Nikkei 225 Index is observed to be skewed higher than the correlation between the Japanese Yen and TOPIX Index.  For instance, from 1 January 2017 to 27 April 2017, the average correlation between the Japanese Yen and Nikkei 225 Index was 3.9% higher than the average correlation between the Japanese Yen and TOPIX Index. Chart 2 displays in a histogram the average 20-day daily correlation per annum between the Japanese Yen and the two Japan equity indices.

Chart 2: Average Annual Correlation Between Japanese Equity Indices and Spot Japanese Yen Fixing
at Cash Close (3.30pm Tokyo Time)

Source: Bloomberg, 27 April 2017. Measuring the average annual 20-day correlation of the daily Nikkei Index close with the half-hourly Bloomberg FX Spot JPY Rate at 1530 Tokyo time.

Taking this analysis a step further, this intertwined relationship is studied with a simple linear regression with the objective of determining how much of the Nikkei 225 Index can be explained by the Japanese Spot Yen. Analysing data between January 2013 and April 2017, the regression derives the equation, where Y (the dependent variable) is the daily Nikkei 225 Index Close and X (independent variable) is the Bloomberg FX Spot JPY Rate at 3.30pm Tokyo time.

The regression model observes that the Japanese Spot Yen movement explains 83% of the variability of the Nikkei225 Index. Furthermore, the model predicts that a one-yen depreciation in the Japanese Spot Yen versus the US dollar will lead to a 232 index point gain in the Nikkei 225 Index.

Implications of Geopolitical Risks on the Japanese Yen (and the Nikkei 225 Index)

Multiple geopolitical risks have diluted risk appetite, from the ongoing Brexit negotiations and French elections to the simmering tensions surrounding North Korea. Due to the perception of the Japanese Yen as a safe-haven currency, investors tend to gravitate towards the Japanese Yen during times of risk aversion, causing the currency to appreciate.

On 23 April, the first round of French presidential elections resulted in a win for centrist Emmanuel Macron and relieved global investors. As a result, the Japanese yen avoided a safe-haven appreciation. As the French go to the polls for a final time on 7 May, the outcome continues to be uncertain.

An election win by Emmanuel Macron may result in a drive to improve France’s competitiveness by shrinking the civil service and eliminating job protections. On the flip side, if the populist Marine Le Pen wins and seeks an extreme scenario where France opts to leave the European Union, a flight to safe-haven assets including the Japanese Yen may occur. 

Another tail-risk event is the possibility that North Korea hostilities devolve into an international crisis. Based on Google Trend data, the “North Korea” search term on Google's search engine has hit its highest level in five years since May 2013. The sequence of events five years ago that triggered a record acceleration of search interest was when North Korea test fired six missiles in three days in defiance of global sanctions. The chart below from Google Trends shows the “spikes” where there is a rapid acceleration of search interest in a topic, compared to usual search volume, which reflects real world concerns.

An escalation in the North Korea hostilities may boost demand for the Japanese Yen as its safe-haven status might trump the proximity risk. In April 2017, the Japanese Yen appreciated 1.8% against the South Korean Won, as global investors continued to buy Japanese Yen even as the risk of regional military conflict increased.  

Chart 3: Google Search Interest for “North Korea”

Source: Google Trends, 27 April 2017. Data is indexed to 100, which represents the maximum search interest from January 2004 to April 2017.

Global Access to the Japan Equity Market

SGX is the dominant offshore Japanese equity index derivatives venue offering the narrowest bid-ask spreads, whilst executing the large majority of offshore Nikkei 225 Index Futures volumes. Since November 2016, trading hours have been extended to open before the Japan cash market and cover the close of US trading. 

Chart 4: Offshore Yen-Denominated Nikkei 225 Index Futures Best Bid/Ask Spreads (Basis Points)

Source: SGX, Bloomberg, February 2017. Based on front quarter month contract.

SGX’s Japan-related equity derivatives are available for trading on all Japanese holidays, with the exception of New Year’s Day (1 January).In addition, margin discounts on spreads formed with other SGX derivatives allow for greater capital efficiency for investors who have views on multiple Asian markets.

Table 1: Trading Hours for SGX Nikkei 225 Index Futures

For more information, please visit www.sgx.com/derivatives/nikkei225.

My Gateway

SGX’s investor education portal with market, product and investment information and events. Sign up now at sgx.com/mygatewayto receive our investment updates and economic calendar.