ZEW Hits Record Lows, LIBOR Woes Hurting Eurodollar

Just another 15 year record low…

German Investor Confidence Unexpectedly Fell in May (Update3): “Investor confidence in Germany unexpectedly fell for a second month in May on concern faster inflation, the stronger euro and fallout from the U.S. housing slump will hurt economic growth.

The ZEW Center for European Economic Research said its index of investor and analyst expectations declined to minus 41.4 from minus 40.7 in April. Economists expected a gain to minus 37, according to the median of 41 forecasts in a Bloomberg News survey. The gauge reached a 15-year low of minus 41.6 in January. A negative reading means that pessimists outnumber optimists.”

In case you live in a cave and missed it, this actually correlates quite well with recent U.S. consumer sentiment… and makes it hard to argue for a 'second half recovery'.

U.S. Consumer Sentiment Decreases to 28-Year Low, (Update1): “Confidence among U.S. consumers fell in May to the lowest level in almost 28 years as record-high fuel prices, lower home values and fewer jobs rattled Americans.

The Reuters/University of Michigan preliminary index of consumer sentiment decreased to 59.5, the weakest level since June 1980, from 62.6 in April. The measure averaged 85.6 in 2007.
Consumer spending, the biggest part of the economy, is cooling as surging food and fuel costs erode Americans' buying power and job losses mount. Declining home prices and stricter lending rules are also preventing owners from tapping real- estate equity to buy expensive items like cars and furniture, raising the risk that growth will stall in coming months.”

I keep saying it, if the economies with most of the world’s wealthy consumers dive into simultaneous recessions, you can’t expect the rest of the world to do well. Everybody, from Latin America, India and China will feel serious pain as they don’t yet have a sufficient consumer base to absorb the higher margin consumer goods they currently produce for export.

TED Spread Falls to 9-Month Low, Signaling Credit Crunch Easing: “Lending confidence at banks rose to the highest level in more than nine months, according to a key market indicator, signaling the global credit crunch is easing.

The so-called TED spread, which measures the difference between what the U.S. government and banks pay to borrow in dollars for three months, dropped below 78 basis points for the first time since August. It held at that level as of 11:56 a.m. in London, after touching 77.7 basis points. The cost of borrowing dollars overnight dropped to the lowest level since December 2004, the British Bankers' Association said today.”

Volatility (VIX) too has dropped drastically. This can’t be good. Complacency is back in a big way. With the S&P 500 (SPX) less than 10% of the record highs reached during the world’s largest credit and real estate bubble, I will say this: Look out below.

Eurodollars' Appeal For Rate Speculation Dims Amid Libor Woes: “Eurodollars, the world's most actively traded futures contract, are becoming a less attractive tool for speculating on Federal Reserve monetary policy amid concern about the accuracy of the London interbank offered rate.

Trading volume in Eurodollars slid 7.5 percent in April from the prior month, to an average of 2.6 million contracts a day, according to Chicago Mercantile Exchange data. Eurodollars are U.S. dollars held in commercial banks outside the U.S. The value of the contract at expiration is determined by the interest rate on three-month Libor, and its yield in the meantime represents the market's forecast.

An average spread of about 11 basis points between Libor and the Fed's target rate for overnight loans between banks since 1997 had made the contract a popular way to make wagers on interest-rate expectations. That changed in the past year as volatility in the difference in the spread surged after the collapse of the U.S. subprime mortgage market, prompting traders to rely more on options such as federal funds futures.”

The financial system is so rotten now that prices of all kinds of financial instruments are being adversely affected. Markets require transparency to most accurate estimate risk. Greater transparency results in a more accurate pricing of risk. This in turn reduces overall volatility and increases price multiples. Now that all major financial participants are busily reducing their transparency, volatility will increase, volume will fluctuate wildly and price multiples have to contract significantly as a greater level of risk must be priced into all financial instruments.

“Trading in fed fund futures, which were first offered on the Chicago Board of Trade in 1988, surged 55.3 percent in April from the prior month to an average of about 98,500 contracts a day. The contracts settled against the average daily fed funds overnight rate as calculated by the Federal Reserve Bank of New York.

Eurodollar futures open interest, or the total number of futures contracts that have not been closed, liquidated, or delivered, declined 17.6 percent in the past two months, according to CME Group data. Outstanding contracts dropped 3 percent in April from the prior month, and were down 21.4 percent versus the previous year. Open interest in fed fund futures at the end of last month more than doubled from the prior month, and has risen 9.2 percent from the prior year.”

Trading the Fed Funds Futures appears to be much safer as, unlike LIBOR, nobody can mess with the calculation.

But before you get excited about the volatility dropping, the TED spread narrowing and LIBOR easing off a bit…

“The difference between the rate of three-month dollar Libor relative to the overnight index swap rate, a measure of what traders' expect the overnight federal funds rate to average over that time, averaged 11 basis points for the 10 years prior to last August, when the global credit crunch began. The spread, known as Libor-OIS, ranged from 24 basis points to 90 basis points this year. A basis point is 0.01 of a percentage point. The gap narrowed 2 basis points to 68 basis points today.”

The LIBOR-OIS Spread is still indicating stress.

“Eurodollar futures are almost useless as a tool for predicting changes in Fed interest-rate policy. With less and less trading in Eurodollar futures, the federal funds contracts are quickly becoming the liquid arena of the fixed income market in terms of betting on central bank policy.” -Stan Jonas, who trades interest-rate derivatives at Axiom Management Partners LLC in New York

“Because Eurodollars settle to Libor, if there is an issue with the Libor fixing, it throws the whole thing off. If you just wish to speculate on what the Fed is going to do, then Fed fund futures are certainly the place to do it.” -Alexander Manzara, a futures broker at TJM Institutional Services on the Chicago Mercantile Exchange

Related Posts:
Libor Poised For Shake-Up, Credibility GONE
RISE Dark Lord Libor! RISE!
Ambac Gets Crushed, Another Bank Wobbles
Fragile Banks: More Bailouts, More Capital
The Race To The Bottom Accelerates
The South Sea Bubble and Today’s Central Banks: FRB, BOE, ECB
Dammit, Why Won’t You Learn?
The TED Spread, LIBOR and EURIBOR = Scary Bad
Mortgage Insurers (Quietly) Downgraded: CDS Spreads Scream Trouble

From Bubble To Bubble, More Hidden Losses

This shouldn’t come as a surprise…

Banks Hide $35 Billion in Writedowns From Income, Filings Show: “Banks and securities firms, reeling from record losses resulting from the collapse of the mortgage securities market, are failing to acknowledge in their income statements at least $35 billion of additional writedowns included in their balance sheets, regulatory filings show.

Citigroup Inc. subtracted $2 billion from equity for the declining value of home-loan bonds in its quarterly report to the Securities and Exchange Commission on May 2 without mentioning the deduction in the earnings statement or conference call with investors that followed. ING Groep NV placed 3.6 billion euros ($5.6 billion) of negative valuations in its capital account, while disclosing only an 80 million-euro depletion to income.

The balance-sheet adjustments are in addition to $344 billion of writedowns and credit losses already reported on the income statements of more than 100 banks. These companies have raised $263 billion from sovereign wealth funds, their own governments and public investors to shore up capital. The balance-sheet writedowns also reduce equity, which needs to be replenished. Adding the $35 billion leaves the banks with a $116 billion mountain of losses to climb.”

It’s those damn account rules.

“Taking losses on a balance sheet instead of an income statement is acceptable under accounting rules, which make a distinction between so-called trading books and long-term investments. Changes in value on the trading side go straight to revenue. Changes in the value of bonds held for the long haul can be marked down on the equity line of a balance sheet, as long as the declines aren't considered permanent.

Banks that are more willing to acknowledge their balance- sheet writedowns, such as Amsterdam-based ING, say the valuations of assets will be reversed when markets recover. ING, the biggest Dutch financial-services company, said in its first-quarter earnings report last week that the drop in the value of bonds tied to home loans that are held to maturity is irrelevant as long as the underlying mortgages don't default.

With that logic, most of the writedowns on the income statements could be reversed if asset prices recover. While some declines in valuations may reverse, most of the losses are permanent impairments caused by surging defaults on U.S. mortgages, said Janet Tavakoli, author of ``Collateralized Debt Obligations & Structured Finance,'' published in 2004 by John Wiley & Sons Inc.”

Worse still, the writedowns are overly conservative. The best evidence of just how inadequate these writedowns really are can be found in the continued explosion of Level 2 and Level 3 asset values. These values are growing rapidly and in many cases now the entire fate of a company rests on these arbitrary values.

For example, just recently Freddie Mac (FRE) moved $156.7 billion, or 23% of its assets, to Level 3. In so doing, FRE was able to report losses of “just” $151 million. By moving $156.7 billion into the Level 3 asset bucket, FRE now has the ability to come up with its own valuation. This was all perfectly acceptable under FAS 157. Despite these desperate measures FRE reported that the “fair value,” or estimated market value of its net assets, was a negative $5.2 billion as of March 31. I can’t imagine that FRE is valuing its Level 3 assets at anything but reckless, fantasy levels. Therefore, I have to assume that the fair value of FRE assets is actually worse than the negative $5.2 billion reported.

I think Janet Tavakoli has it just about right:

“Of course we can't tell how much of a bank's portfolio may actually be good stuff that will pay back at maturity. But there's tremendous value loss that's fundamental, not just due to credit market gyrations.” –Jane Tavakoli, author of “Collateralized Debt Obligations & Structured Finance

That means those asset prices won’t come back… EVER.

“Ignoring bad debt and postponing inevitable losses was one of the main reasons behind Japan's decade-long economic slump that began in the 1990s, said Boston University law professor Charles Whitehead.

Faced with new capital requirements and a weakened ability to meet them, Japanese banks deferred the recognition of their losses, aided by regulators who refrained from implementing the rules, Whitehead wrote in a 2006 paper published in the Michigan Journal of International Law.

The new bank-capital regime, known as Basel II, has gone into effect in some European countries and is being implemented in the U.S. and others starting this year. It allows financial institutions to use in-house risk models instead of just relying on external credit-worthiness ratings in calculating their risk- weighted capital requirements.

The largest U.S. securities firms have been under capital requirements shaped by Basel II since 2004.”

So, despite Bernanke having specialized in the great Depression and having written papers criticizing how Japanese authorities handled their own real estate and credit crisis, Bernanke looks set to repeat exactly those same mistakes.

“U.S. regulators may be tempted to go soft on banks too. The new capital rules already rely significantly on self-modeling by the banks. So if anything, the risks may be greater in the U.S. today than they were in Japan in the 1990s.” –Charles Whitehead, Boston University law professor

“A review of the balance sheets and regulatory filings of more than 50 banks showed that 20 of them chose to keep some subprime- related losses off their income statements. The marks were recorded instead on balance-sheet items labeled “other comprehensive income” or “revaluation reserves.”

This is exactly what the Japanese did. They ended up with a Zombified financial system for the next 15 years. Despite the fancy accounting footwork there are more losses yet to come.

“Declines in asset prices have spread beyond subprime though, affecting other mortgage bonds, securitized car and student loans, leveraged lending that backs private equity buyouts and credit derivatives. When all that is included, the IMF estimates that total losses from the U.S. subprime debacle will reach $1 trillion, of which $510 billion will be born by banks. That means some $130 billion in losses remains to be taken.”

The S&P 500 bounced significantly of the panic lows around 1255, but the banking and mortgage indices have not. With more writedowns pending, that makes sense. What does not make sense is the assumption that crippled banks won’t seriously negatively affect the broader economy. When that finally becomes obvious it will unleash a real vicious Bear market…

Related Posts:
Bulltrap: ABCP, and Level 3 Bombs (A list of Level 3 assets by firm and by amount)
Something To Think About: Goldman Sachs, Level 3
Level 3 Rules

Oil Producers Mask Decade's Worst S&P 500 Profit Drop (Update1): “Take away Exxon Mobil Corp., Chevron Corp. and ConocoPhillips and profits at U.S. companies are the worst in at least a decade.

Without the $70 billion that oil producers earned in the last two quarters, profits at companies in the Standard & Poor's 500 Index tumbled 26 percent and 30.2 percent, the biggest decreases for any quarter since Bloomberg started compiling data in 1998. Energy companies made up almost half the income growth reported by S&P 500 companies in the first three months of 2008 as oil prices surged past $100 per barrel, the data show.

The results leave the benchmark for American equities vulnerable to declines as oil companies' costs balloon and production slips. The industry is getting less profit from a barrel of oil than at any time since 2005, just as the rest of the U.S. economy is sputtering. Still, energy shares posted the S&P 500's steepest gains in the past year, bloating their representation to 15 percent of the index.”

The better energy does, the weaker the rest of the S&P. The effects of energy temporarily mask some of the weakness in the rest of the S&P. Furthermore, the better energy does, the more pressure it puts the rest of the economy. High energy prices are adding stress to an already stressed financial system. Consumers have clearly started to buckle. When they finally start defaulting on revolving credit with any significant scale, it will come at a time when banks are particularly vulnerable.

Pre-market oil is again at new record highs.. again. Oil has hit the runaway, parabolic, super spike phase of its speculative cycle that can only end in a massive blowout top. Unfortunately this means prices will probably carry to some ridiculous level that effectively sucks all the oxygen from the global economy before marking a top. This will cripple and even collapse most other asset classes unleashing slective asset price deflation. Then as oil collapses itself, true GLOBAL deflation will set in as credit is destroyed the world over and all asset classes get sucked down until they are valued at low or no leverage prices.

TIPS Show Bonds See Bubble Burst for Commodity Prices (Update2): “Treasury bond traders are telling Americans to stop fretting about inflation.

Consumers expect prices to rise 5.2 percent in the next 12 months, according to a monthly survey by the University of Michigan in Ann Arbor, the most pessimistic they've been since 1982. Treasury Inflation Protected Securities, or TIPS, show traders anticipate inflation of about 2.9 percent by January, in line with its average of 3.1 percent the last 20 years.

The disparity has never been wider. While consumers grapple with gasoline above $3.70 a gallon, record rice prices and the escalating cost of wheat, TIPS say the commodities market is a bubble about to burst. A commodity slump would worsen losses in the $500 billion TIPS market, where investors lost 2.35 percent in April, the most since December 2006.”

“There's a lot of people who just don't believe the economy's going to stay strong enough to keep prices of things where they are. Part of what's going on here is a lot of people view this price rise in oil, a lot of commodities, as being somewhat bubbleish and that they'll come off again very quickly.” -Chris McReynolds, who trades TIPS in New York at Barclays Plc, the largest dealer of the securities

From one bubble to the next… Long live cheap and easy money! Long live the age of Fiat Currency!

Related Topics:

A speech by Bernanke in May 31, 2003: Some Thought on Monetary Policy in Japan: “Rather, I think the BOJ should consider a policy of reflation before re-stabilizing at a low inflation rate primarily because of the economic benefits of such a policy. One benefit of reflation would be to ease some of the intense pressure on debtors and on the financial system more generally. Since the early 1990s, borrowers in Japan have repeatedly found themselves squeezed by disinflation or deflation, which has required them to pay their debts in yen of greater value than they had expected. Borrower distress has affected the functioning of the whole economy, for example by weakening the banking system and depressing investment spending. Of course, declining asset values and the structural problems of Japanese firms have contributed greatly to debtors' problems as well, but reflation would, nevertheless, provide some relief. A period of reflation would also likely provide a boost to profits and help to break the deflationary psychology among the public, which would be positive factors for asset prices as well. Reflation--that is, a period of inflation above the long-run preferred rate in order to restore the earlier price level--proved highly beneficial following the deflations of the 1930s in both Japan and the United States. Finance Minister Korekiyo Takahashi brilliantly rescued Japan from the Great Depression through reflationary policies in the early 1930s, while President Franklin D. Roosevelt's reflationary monetary and banking policies did the same for the United States in 1933 and subsequent years. In both cases, the turnaround was amazingly rapid. In the United States, for example, prices fell at a 10.3 percent rate in 1932 but rose 0.8 percent in 1933 and more briskly thereafter. Moreover, during the year that followed Roosevelt's inauguration in March 1933, the U.S. stock market rallied by 77 percent.”

Related Blog Posts:
Mish:
Misconceptions About Gold
Why Does Fait Money Seemingly Work?

Related Posts:
Fannie Mae and UBS Miss, Bankruptcy Filings Up Big Time
Sarcastic Rant on Fannie and Freddie.
Fannie Mae, Freddie Mac: The Dumbest Idea Ever
Fannie Mae: Another Shoe Drops

Black Russians, Lemurs, Milipedes and Lots of Rage

A quick summary of trading week. Cool stuff only of course...

Corey Rosenbloom at Afraid To Trade thinks: Indexes Confused - Trapped. I couldn't agree more. I see the same indecision in: Gravestone Doji And Cool Correlations and Fibonacci Heaven where I argue its pop or drop time. Emphasis on the DROP.

For weeks now former Fed Chairman Paul Volcker has been talking tough and slinging mud. He does not like what Bernanke has been up to at all. Calculated Risk has Volcker saying: No Reason for Complacency. The market isn't listening. Volatility, as measured by the VIX continues to drift lower. I caught it early in: Bulltards Grow Complacent: VIX Drops. When the credit crunch was just still in it's infancy I said: We Need Another Volcker and Kill The Greenspan Put, but the powers that be just did more of the same. while babbling about Moral Hazard.

Early this week I boldly announced my intent to go short Apple in: Can't Resist Apple: Way Too Ripe, Way Too Juicy. Sacrilege! Apple is sacred. I know. I know. Today, over at Slope of Hope, Tim Knight took the same bold step and suggested going short Apple for the same reasons. In New Apple Store Unveiled Corey Rosenbloom didn't get Bearish on the company, but he does express caution about the chart...

Pre-market Friday morning equities took a hit and fixed income found a bid on rumors that the last Non-Farm Payrolls had been MISCALULATED and that the real number is much much worse. NO SHJIT, maybe they'll finally scrap the Net Birth/Deaths Model crap. I can't emphasize enough how informative Paper Economy is. Check out Economic Jolt: Job Openings and Labor Turnover if you want to a grasp on the labor market. In Confidence Game, Paper Economy tackles truly dismal consumer confidence numbers.

Which reminds me: Mish does a fine job illustrating how California Leads The Way To A Consumer Bust. This is how job losses accelerate rapidly. This is how taxes accelerate upwards rapidly. By borrowing against FUTURE lottery income to sustain current ridiculous spending levels, 'The Arnold' demonstrates that despite his crazy accent he truly is Americanized. More debt clearly solves all debt problems, that is the American way!

Back to housing. New Residential Construction got the talking heads on BubbleVision all excited because the numbers came in better than expected. Somehow, a Bullish spin was put on this: "Single family housing permits, the most leading of indicators, again suggests extensive weakness in future construction activity dropping 40.07% nationally as compared to April 2007." Paper Economy doesn't get distracted by the hype.

Karl Denninger over at Market Ticker pokes fun at the ECB for noticing that "banks are exploiting its efforts to unblock the frozen funding markets by using its liquidity scheme to offload more risky assets than envisaged" in his post Fraudulent Friday. Mish took notice as well in ECB Concerned Over Swap-O-Rama Exit Strategy and the guys over at Naked Capitalism caught it as well in Quelle Surpise! Banks May Be Gaming ECB Liquidity Facility. Since this is serious stuff and it is way too late for an easy out, I poured myself a gigantic Black Russian...

The third DOUBLE Black Russian resulted in my exploring the possibility of starting my own goddamn-bank-that-has-access-to-the-goddamn-discount-window-and-can-punk-off-crappy-collateral-for-real-bling...

Then I thought about taxes and got real angry... because this fine mess can only result in higher taxes in the near future as all these losses end up being nationalized, socialized and otherwise dumped on everybody BUT those responsible for them.

The fourth double Black Russian calmed me down a bit as I realized that sweet-baby-jesus, I was in Canada... and that Canada is still running massive surpluses off that dirty commodity money. Oil, gold, copper, zinc... all of it. We just keep pumping it out as the US dollar keeps spiraling down into the abyss... and I thought maybe, just maybe ONLY YOU GUYS would get screwed in the long run.

Watch the video Lemurs Get High and substitute the following: Consumers for Lemur and Debt for Millipede. Disturbing. Freaky. Hilarious... and strangely, very very relevant. Just watch and think: LEMURE = CONSUMER and MILLIPEDE = DEBT.

I should definitely get another drink...

Fibonacci Heaven, Equities Party On

The international indices are all in Fibonacci heaven. All the indices have bounced and are now entangled in the 50% retracement level. A couple indices have had the strength to make it all the way to the 61.8% level. ONE index appears to be invincible: The Brazilian BOVESPA.

It is pop or drop time across the globe. Since economic data continues to deteriorate, I would argue for more drop than pop.

A quick recap and update on some of my recent posts and chart comments:

Gravestone Doji And Cool Correlations: Volatility, Yen: "We may have a Gravestone Doji here on the S&P 500 (SPX).

In a bullish trending market the gravestone illustrates an unsustainable bull rally where price drives up to new highs in trading on day two, but sellers take control by market close.

Although this formation is a moderate to weak in signal strength, it is a warning for longs that the uptrend is losing momentum and bears may retake the market soon.

Since prices have fallen out of the rising Bear Wedge and have now rallied and tested the previous high of the 1420 area, the Gravestone Doji is more relevant than usual. Today's price action must not exceed yesterday's high and preferably result in a down day..." -TheFinancialNinja, 05/15/08

UPDATE: Well, THAT doesn't seem to be working out well. All is not lost YET, but its damn close. The Bears have to hold the line here or we can easily see a move into the 1450, and 1470 areas.

MBIA Reports Scary Earnings; NEGATIVE Revenues: "The short opportunity did not last long on BKX as the price only 'spiked' into the zone around $88, before getting SLAPPED BACK DOWN. Expect some support around $80 here and then again around $75. I do expect that the lows eventually won't hold." -TheFinancialNinja, 03/28/08

"Rejected! Same price as last time and just as quick." -TheFinancialNinja, 05/12/08

UPDATE: While the S&P 500 (SPX, grey area) continues to party on, the banks have dropped out to nurse their hangovers. So how much staying power does the current rally have then in the broader market indices?

"Fannie Mae (FNM) and Freddie Mac (FRE) earnings were scary bad. Ambac (ABK) and MBIA (MBI) earnings were scary bad. MFX is likely to test the lows in the near future." -TheFinancialNinja, 05/12/08

UPDATE: The S&P500 (SPX, grey, area) has rallied to 1420 and the mortgage complex hasn't kept pace. It’s pop or drop time here. A big move in either direction is building... I'm partial to a downside break below $40 based more on fundamental than technical developments.

U.S. Foreclosures Rise 65 Percent as Vacated Homes Add to Glut: “U.S. foreclosure filings climbed 65 percent and bank seizures more than doubled in April from a year earlier as mortgage industry efforts to modify loans fell short.”

Remember that? It came out only two days ago. This came out this morning:

U.S. Builders Broke Ground on Fewest Houses Since '91 (Update1): “Construction of U.S. single-family houses in April dropped to the lowest level in 17 years, even as building of condominiums and townhouses rebounded.

Builders broke ground on 692,000 single-family homes at an annual rate, down 1.7 percent from March and the fewest since January 1991, the Commerce Department said today in Washington. Total housing starts jumped 8.2 percent to a 1.032 million pace that was higher than forecast as construction of multifamily units increased 36 percent following a 35 percent drop in March.

Building permits, a sign of future construction, rose 4.9 percent to a 978,000 pace, reflecting gains in both single- and multifamily units.”

Since the numbers were BETTER than expected, equity futures found a bit of a bid. BETTER? I’d say worse. With a giant tsunami of supply about to hit the market in the form of foreclosures ANY tick up in New Housing Starts and Building Permits should be considered bad. Now is not the time to increase the supply of residential real estate...

Building more just doesn't seem like the clever thing to do right now...

Gravestone Doji And Cool Correlations: Volatility, Yen

We may have a Gravestone Doji here on the S&P 500 (SPX).

In a bullish trending market the gravestone illustrates an unsustainable bull rally where price drives up to new highs in trading on day two, but sellers take control by market close.

Although this formation is a moderate to weak in signal strength, it is a warning for longs that the uptrend is losing momentum and bears may retake the market soon.

Since prices have fallen out of the rising Bear Wedge and have now rallied and tested the previous high of the 1420 area, the Gravestone Doji is more relevant than usual. Today's price action must not exceed yesterday's high and preferably result in a down day...

Using the ProsShares Ultra Short S&P 500 (SDS, candle) to represent the inverse of the S&P 500 and plotting the price action against the volatility (VIX, grey area) the positive correlation between the two becomes crystal clear. As VIX falls, the market rises. Conversely, extremely high VIX readings in excess of 30 tend to set bottoms (in the case of SDS, tops). A reading of less than 20 on the VIX now, probably represents extreme complacency for this time of environment. I would therefore expect and look for general equity weakness.

Using the ProsShares Ultra Short S&P 500 (SDS, candle) to represent the inverse of the S&P 500 and plotting the price action against the Yen index (XJY, grey area) the positive correlation between the two becomes crystal clear. As XJY falls, the market rises. Conversely, as the Yen strengthens it confirms risk aversion as Yen Carry Trades are unwound and risky assets, such as equities, are sold.

Putting the two together results in a set of nice leading indicators at best and confirmation at worst. For example, not sure if a decline in equities will stick and last a few days turning into a significant correction? Check to see if VIX has risen from a low enough a level to give it reasonable room to run and check to see if the Yen has shown strength and is technically poised to rally further.

If you want to get really crazy, pull them both up on 5, 15, and 60 minute charts and use them as intraday signals.

Related Posts:
Finally, Dollar Smile Theory In Play?
The Yen As A Leading Indicator
Watch The Yen, Carry Trade Unwind
Bulltards Grow Complacent: VIX Drops