USDJPY <-> The World; Carry Trades, Safe Havens on the VIX Scale

OANDA:USDJPY   U.S. Dollar / Japanese Yen
The Title Chart is a representation of the impact of each 1% change in the ( SP500 ) VIX on various currencies' (and Gold ; Bitcoin ) to tend to more (or less) toward Risk (instability) or Safe Haven (stability) characteristics.
I.e. It depicts the relationship between market uncertainty and exchange rate movements of safe haven currencies (and currency "equivalents")

An important note on: Context!

View this article in the light of two, undisputed facts;

  • Margin debt – the amount of money that investors have borrowed in order to buy stocks – is now at the highest level in history, not only in absolute terms, but also relative to U.S. GDP.

  • The present ratio of U.S. total equity market capitalization to GDP is 2.63. The historical norm (not the low!) is 0.78. - Which is about 70% below the current level.

In light of the above facts the central question remains the same; Can business as usual continue (and for how long?) or, is there is a global, catastrophic financial collapse on the horizon?... You decide. (This post may help;!/8...)

The remainder of this article is based on various notes and research, taken at a RIETI Conference (Research Institute of Economy, Trade and Industry), a couple of years ago - before the Covid Pandemic.
However, I shall omit most (if not all) of the technical details, calculations and such here, for brevity and clarity's sake.


The Japanese yen and the Swiss Franc are often called a safe haven currency—a currency that appreciates when the risk-averse behavior of global investors and the uncertainty of economic policy and outlook increase, while the U.S. dollar is regarded as the most reliable international currency as an anchor. The safe haven status is usually observed for a country that has the current account surplus, low interest rates—the funding source of carry-trade opportunity—, and the investors’ perception as the safe-haven currency, resulting in suffering from the deterioration of the trade balance during a crisis. That may improve the trade balance of the country’s trade partners and competitors, especially if their currencies are vulnerable to a shock. The yen tends to rise during periods of increased financial market volatility . This tendency—clearly evident when the currency surged after the Brexit shock—has strengthened since mid-2015. While widening yield differentials between the U.S. and Japan are a force to weaken the yen, the currency is vulnerable to sudden gains on higher risk aversion
The Chinese renminbi ( CNY ) is a rising star. Its internationalization is on the fast track .The renminbi’s inclusion into the SDR basket represents its internationalization, making the renminbi a reserve currency alongside the USD, the JPY, the EUR, and the GBP. Still, the renminbi was depreciated by 4% between its announcement on November 30, 2015 and actual inclusion on October 1, 2016. Recent political uncertainty generated unexpected shocks—from the U.S. presidential election to Federal Reserve interest rate decisions and political events in Europe—that could affect sentiment toward the yen, the renminbi, and relatively vulnerable Asian currencies, increasing safe-haven demand for alternative assets such as gold and bitcoin .

The yen’s safe-haven status may signal in advance shifts in risk appetite in the foreign exchange market. The skew in risk reversals on yen-dollar currency options, which turns negative when bets on yen appreciation outweigh bets on depreciation, tends to follow, or is at least associated with, the index. For example, 12 weeks after the start of a VIX spike, net non-commercial positions on the yen on the Chicago Mercantile Exchange are 20 billion U.S. dollars longer than would be the case absent the rise in the VIX .

In the European sovereign crises of 2011, the yen was purchased aggressively as a safe asset3 and finally reached the historical high value, 75.54 yen per dollar and remained around 80 yen. Thus, just after the East Japan Earthquake and the meltdown of nuclear power plants, the highest value of the yen is hard to be explained by economic fundamentals. In January 2015, the Swiss National Bank (SNB) abolished its exchange rate cap against the euro , meaning that the SNB stopped intervening by purchasing the Swiss franc against the euro . As a result, the Swiss franc was appreciated against U.S . dollar by 30% within 10 minutes .

At the same time the yen and the Singapore dollar were appreciated by 1% as investors needed to sell the euro and buy some safe currencies instead of the Swiss franc that was limited liquidity and capacity compared to the euro . So, not only the yen and the renminbi, but other currencies in the Asian emerging market may be in transition to the safe-haven status.

Here, one tries to measure whether the yen, the renminbi, other currencies, and alternative assets have a safe-haven or vulnerable status. Introducing long-term and short-term gauges help judge if the safe-haven status is temporary or consistent. The results shows that the yen consistently has the safe-haven status, the renminbi temporarily obtained the safe-haven status in early 2010, but has been returning to a vulnerable currency.

Increasing political uncertainty in the global market and weakness of the renminbi may increase demand for traditional and innovative alternative assets, though the size and liquidity of the markets haven’t developed well, yet and they are vulnerable to regulatory changes. A bitcoin price surged in late 2016 as the renminbi depreciates, but it tumbled to $789 on January 11, 2017, down 28% from a peak of $1,091 on January 4, 2017. The proximate cause – signals from China’s central bank that they are paying close attention to irregularities in the market.

The still relatively small size of the market makes bitcoin impractical as a channel for large-scale capital flight. Gold could be considered as a good asset in the diversification of Chinese portfolios. Wong and Zhu (2015) find, however, it is only for risk-seeking investors and in crisis periods on the Shanghai Gold Exchange in the diversification of Chinese portfolios. So, there are very limited indications that bitcoin and gold could be presently regarded as a safe-haven assets, and while their safe-haven tendency might be increasing, it is particular and limited to relative to the renminbi, under high policy uncertainty.

Safe Haven Trades - Short-term Perspectives

There are standard and widely available models that captures the safe-haven status of a currency in the short-term and they rely on the assumption of capital flows driven by excess returns from the currency carry trade, rather than uncovered interest rate parity (UIP). The carry trade hypothesis defines the currency carry trade, which consists of selling low interest-rate currencies “funding currencies” and investing in high interest-rate currencies “investment currencies.” They find that carry trades loses money on average, in times of rising VIX . While the UIP hypothesizes that the carry gains due to the interest-rate differential is offset by a commensurate depreciation of the investment currency, empirically the reverse holds. The investment currency appreciates a little on average despite with a low predictive R2 (Fama1984). This violation of the UIP – often referred to as the “forward premium puzzle” – is precisely what makes the carry trade profitable on average.
To be able to successfully solve the UIP “forward premium puzzle” (successful carry trade), the addition of a gauge of market risk sentiment to predict the future spot exchange rates is essential.

To predict the change in the expected exchange rate is usually explained by a change in interest rate differentials and the market risk sentiment. To capture the impacts of a change in the market risk sentiment on exchange rates, a rolling OLS regression of a daily change in the VIX and the two-year yield differential between local currency and the U.S. dollar on a percentage change in local currency per dollar is used.
Normally, The VIX is a good measure of investors’ risk sentiment. Increases in the VIX are associated with higher volatility in Japanese and Germany stock prices, as measured by the Nikkei VI and VDAX, as well as in the yen’s exchange rate to dollar. The VIX correlates, under normal circumstances, to the Nikkei VI at 0.83, to the VDAX at 0.87 and to implied volatility on 1- month at-the-money yen-dollar options at 0.71, with the addition of the two-year government bond yield differential. A standard model would go something like this;

dLn(LCY/USD) = a+b1d(USDLCY_2Y)+ b2 𝑑(𝑉IX)+e

where "LCY" means the local currency, USDLCY_2Y is two-year government bond yield differential, the VIX denotes the implied volatility of S&P 500 index options6, "e" is an error term. The UIP assumes the sign of the coefficient of USDLCY_2Y is negative, while the carry trade hypothesis sees its sign positive during a normal period. So, the determinants of its sign are answers to an empirical question, rather than a theory.
The coefficient of the VIX is defined as the Safe-haven Currency Index ( SCI ) and assessed the safe-haven status as follows:
  • SCI > 0: Period and country specific "safe-haven" type tendency.
  • SCI < 0: Period and country specific “vulnerable currency" type tendency.
  • SCI = 0 or insignificant: exchange rate movement doesn’t follow a specific tendency.

Safe Assets – Long-term Perspective

The safe asset indexes indicate mostly three currencies – the Swiss franc , the yen, and the dollar – out of the 13 currencies which mormally maintain safe-haven status.
Although the Swiss franc has the strongest safe-haven status on average, its status has been weakened from 2007 until 2011 – the period of the Global Financial Crisis and the European Sovereign Crisis.
That is likely because Switzerland has suffered from rapid currency appreciation against the euro and thus, its safe-haven demand relative to the dollar seemed to be limited. In contrast, growing dollar demand during the crises had strengthened the dollar’s safe-haven status. The yen has consistently kept the safe has status during previous risk-off episodes.

However, the currency status of some currencies has been switching between a safe-haven and a vulnerable currency. The British pound had had the safe-haven status until early 2000s, but it fell into the vulnerable currency status from 2007 until 2015, followed by a rapid depreciation due to the Brexit shock in June 2016. On the other hand, the Singapore dollar was the vulnerable currency until 2011, turning into the safe-haven currency around 2011.
Thus, the safe-haven status doesn't necessarily last forever, and it does change overtime. Higher frequency data provides the detailed transitional status in the short-term perspective.
The safe-haven status seems to be associated with the internationalization of the currency. The dollar has about 90% of the total share (200%) of turnover of Over-The-Counter (OTC) of transaction from 1995 until 2016.
The yen’s share is about 20% throughout the same period. The shares of the European currencies such as the euro , the pound, and the Swiss franc have peaked in 2001; they have been gradually shrinking ever since.
In contrast, the Asian currencies have been consistantly emerging, in the meantime. The share of the renminbi, the Singapore dollar and the Won reached 4%, 2%, and 2% from 0%, 1%, and 0%, respectively.

Safe Haven versus Vulnerable Currency – Short-term Perspective

Uncertainty represented by the VIX affects exchange rate movements on a daily basis, given limited fluctuatuons in the two-year interest rate differential between the local currency and the dollar. Zero interest rates are applied for alternative assets.

The Yen

The Safe-haven Currency Index suggests that the yen has kept its safe-haven status during the global crises. The results of the ordinary least square rolling (OLS) regression in daily data supported this scenario. The yen’s safe-haven status has been held firm since 2007 except for a period of the aftermath of the Great East Japan Earthquake and the downgrade of the U.S. sovereign rating d by Standard and Poor.
Still, even when the yen had its vulnerable status period, it still wasn't significant.

Since market participants tended to expect higher possibility of massive monetary easing as the part of the Abenomics in late 2012, the yen’s safe status has been strengthening. The index shows that each 1 percentage point rise in the VIX is associated with a 0.13% appreciation in the yen as of January 26, 2017, while 1 percentage point increase in two-year interest rate differential between the U.S. and Japan is accompanied to an 11.4% appreciation in the yen. The negative coefficients of U.S.-Japan interest differentials held virtually for ythe entire period.
Removing the yield differentials strengthens the absolute impacts of a change in the VIX , but it doesn’t change the robustness of the yen’s safe-haven status. These results support the carry trade hypothesis rather than the UIP.
A shift in the monetary policy framework helps explain a change in the yen’s safe-haven status. Lower interest rates increase opportunity for the carry trade, strengthening the save haven status. The structural breaks for the safe-haven status are tested with the Schwarz criterion in global information criteria. The test signals July 21, 2006, August 31, 2010, and January 31, 2013 as the timings of structural breaks.

These dates are relevant to significant changes of monetary policy framework in Japan. The Bank of Japan lifted the quantitative easing policy in March 2006 and the zero-interest-rate policy in July. The BOJ introduced ‘comprehensive easing policy’ in October 2010, and the BOJ introduced asset purchase programs in April 2013. The coefficient of the VIX was around zero in late 2012, but it dropped to -0.25% in early 2014. Further monetary easing appears to enhance the yen’s safe-haven status. During the same period, Japan’s net foreign asset relative to the GDP has been highest in the world, but it has decreased in the dollar terms.
Consequently, investors’ risk appetite and their perception for the yen’s safe-haven status would play a vital role in the determination of exchange rate movement. The strength of its status may rely on excess profits from the carry trade rather than economic fundamentals such as net foreign assets and reserves.

The long-term government bond yields contain more risk premium than short-term yields. Still, the yen’s safe-haven status, which reflects invertors’ risk appetites, is robust even if adding in a change in the yield curve: the ten-year, two-year spread between the U.S. and Japan. An increase in the spreads means the U.S. government bond yield curve is getting steeper relative to the Japanese government bond yield curve. The coefficient of the VIX remains significant overall even if a rolling regression is implemented with the yield curve variable.

These results suggest a higher level of VIX predicts higher returns for investment currencies and lower returns for funding currencies, and controlling for VIX reduces the predictive coefficient for interest-rate differentials. That is consistent with the carry trade hypothesis.

Renminbi’s Shift to Vulnerable Currency Status

The SCI suggests the renminbi is a vulnerable currency except the period of 1997-2001. As capital flows from and into the Mainland China are restricted its interest rate differential to another currency and the VIX haven’t well tracked the movement of onshore renminbi ( CNY ). In order to capture the investor’s risk perception under uncertainty, the offshore renminbi ( CNH ) might be the more appropriate gauge of the safe-haven and vulnerable status. In fact, during the risk episode such as the U.S. sovereign credit downgrade, CNH tended to depreciate more rapidly than the CNY did.

The tests for safe-haven status of the CNY are neither stable nor significant, not only against the Dollar but also the Euro .
In contrast, the CNH’s vulnerable currency status against the dollar and the yen is readily observable and consistent.

All the while its status relative to the Euro was regarded as a safe-haven until April 2014, significantly shifting to a vulnerable currency by May 2015. These results are consistent with structural breaks, overall.

Alternative Assets: Gold and Bitcoin

Those two asset classes reamin relatively fractional to global risk assets and stock market market capitalization. As of this writing, they remain miniscule to even consider them as alternatives in light of the $75-$220 Trillion (depends who is counting) total, unfounded, global liabilities.


All of the above suggest that the Yen is a safe-haven currency as well as safe asset and it's status as such is unlikely to diminish in the foreseeable future.
Its safe-haven status is stronger on average than other safe-haven currencies such as the Swiss franc and especially far outpacing that of bitcoin and gold .

The offshore traded renminbi ( CNH ) maintains a very much vulnerable status to the U.S. Dollar and the Japanese Yen and this is has also minimal impetus to changes in the foreseeable future.

Higher market uncertainty with policy swings may increase safe-haven demand for alternative assets such as gold and bitcoin but there are certainly no tendencies at present that, given these alternatives' very limited liquidity, they would factor as substitutes for the Yen or the US Dollar in the foreseeable future.

Comment: Here are a number of relevant FX pairs to this article;

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