Global markets were rocked by Brexit vote on June 24. The result was a drop in the USD/JPY pair to a low of 97.79 levels on June 24. Dow index also printed a low of 17,063 on June 27.
World didn’t come to an end after Brexit, but…
Contrary to the argument put forward by pro-EU camp before the referendum, the world did not come to a post Brexit. However, the one-day shock and awe in the markets and the resulting drop in the USD/JPY pair to 97.79 wax enough to trigger speculation the Bank of Japan (BOJ) and Japanese government would do more.
Corrective move in FTSE100 and USD/JPY to 103.39 after Brexit vote helped Dow recover to 18,000-18,100 levels. The real fun began on July 11 after Abe’s landslide victory in elections convinced markets that the PM now has more scope to deliver a much needed stimulus.
USD/JPY opened at 100.59 on July 11 and clocked a high of 107.49 on July 21. The entire rally was due to expectations the Japanese government would deliver fiscal stimulus in support of additional stimulus from Bank of Japan. During the same time Dow jumped from 18,000 to record high of 18,622 levels.
Thus, the rally in Dow Jones appears to be Yen funded. Increased bets of fiscal stimulus triggered Yen carry trade.
What if BOJ/Japanese government disappoints?
Monetary and fiscal stimulus appears to have been priced-in by markets. However, if there is a disappointment on monetary or fiscal front or both, then USD/JPY risks a sharp snap back. Sudden reversal in Yen could weigh over Dow index, in which case the index could at least retrace below sub 18K levels. In case the stimulus goes to extremes, a sell-off in Yen if not accompanied by Japanese bond market jitters could pull Dow to further highs.
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