Illustrating once again how dependent global markets are on central bank liquidity, global markets tumbled into Risk Off mode after Bank of Japan (BOJ) Governor Kuroda offered no additional stimulus measures on April 28. JPY jumped by an exceptional 3.2σ vs USD as Japanese equities plunged by 2.8σ, taking global equities into the red. DJIA experienced its first negative outlier since 20 Jan, showing the extent of global contagion. Fig 1. shows a ranking of cross asset outliers on 28 April, which resembles a classic flight to safety pattern (negative equity outliers & positive Gold outlier).
Fig. 1. Cross Asset FNA Correlations ranking of top outliers on 28 April
Seatbelt time again?
On Friday, JPY rose to an 18 month high vs USD, Gold experienced another positive outlier to reach a multi-year high, and global equities bled. Global markets are getting nervous again. Although volatility declined on Monday (VIX below 15 again) as equities bounced, investors should not be surprised to see increased market volatility given significant systemic risk. A jump in global equity volatility would continue to favor JPY, as well as VIX, US 20Y+ Government Bonds and Gold. These Flight To Safety Assets have shown the most consistent negative correlation to equities (red links) throughout 2016.
Japan equity predictive stress test
Japanese equities look especially vulnerable, given lack of BOJ support. In Fig 2 below we simulate at -3σ MSCI Japan predictive stress test, ranking most affected assets on the left panel. JPY and VIX Futures are the most effective insurance, while Gold and US government bonds & TIPS also show significant appreciation.
Fig. 2. -3σ MSCI Japan predictive stress test on Cross Asset FNA Correlations
We discuss the dynamics of last week’s BOJ surprise in Video 1 below.
Video 1: Systemic implications of JPY surge & flight to safety (4:25 min).