Systemic Liquidity Risk and Bipolar Markets: Wealth Management in Today's Macro Risk On/Risk Off Financial Environment

8

The Aussie/Yen Connection

A central theme of this chapter will be to demonstrate that the Australian dollar can be seen as an excellent proxy for the risk on phases in contemporary asset markets. On the contrary, the Japanese yen can be seen as a proxy for risk off behavior for reasons which we have already touched on in the previous chapter.

To begin our exploration of the connection between these two diametrically opposed financial instruments our initial focus will be on the Australian dollar. The currency has enjoyed its status as a beneficiary of global growth and positive economic fundamentals as a result of being buoyed by the demand for its mining and resources from China and other rapidly developing markets. To the extent that such demand from China and other emerging market (EM) economies remains buoyant this is a “bullish” macro dynamic and thus a driving force for positive risk appetite characteristics. Moreover, short-term tactical implementation of FX carry trade inspired strategies by hedge funds reveals the risk on/risk off dynamics in the movement of such key FX pairs as AUD/JPY and AUD/USD (given the very low rates now applicable in the USA, the US dollar has become a funding currency). [1]

In the discussion of the VPIN metric and the precipitating factors that triggered the Flash Crash of May 2010 there was a discussion of the role played by the large move in the exchange rate of the yen against the US dollar immediately prior to the large moves down in the ...