Divergence Trade: Sell Euro Buy Yen

Forex experts see a new profitable trade in the coming months. Their advice is to forget about the Fed and whether or not it will raise rates. Bloomberg Business suggests that a policy-divergence trade is the way to go. Sell Euro and buy Yen.

The best way to profit from differences in central banks’ monetary policies is to sell euros and buy yen, according to Nomura Holdings Inc. and Societe Generale SA.

They’re betting the European Central Bank will boost its stimulus program while its Tokyo-based counterpart stands pat — an expectation that’s reflected in the biggest gap in interest-rate swaps denominated in the euro and yen since the euro’s 1999 debut. The shared currency touched a six-month low versus the yen last week.

“There’s more room for euro depreciation against the yen than the dollar,” said Olivier Korber, a Paris-based strategist at SocGen. “The dollar has already priced in the new Fed rate expectations, while Draghi has been consistent in saying there will be more policy action, and the Bank of Japan’s lack of action means there is no catalyst for a weaker yen.”

Central bank policy or anticipated policies are driving Forex markets. And when monetary policies diverge there is a profit to be made. The divergence trade is to sell euro and buy yen.

Euro

Other traders have developed an appetite for risk and are selling the Euro in favor of more volatile currencies such as the Australian dollar according to Reuters.  This risk appetite is driving the Euro lower and the AUD higher.

The euro dipped against a broadly stronger dollar on Tuesday, as investors regained some risk appetite and sold the single currency in favour of riskier ones such as the Australian dollar.

As global stocks hit a 2 1/2-month high, the euro followed European bond yields lower, falling 0.4 percent at $1.0969 . The single currency is increasingly used to fund so-called “carry-trades” in which investors borrow a low-yielding currency and sell it to buy a higher-yielding one.

The Australian dollar, which is viewed as high-risk among developed world currencies and which is closely linked to the Chinese economy, fell as much as 0.9 percent against the dollar after the Reserve Bank of Australia declined to cut interest rates further.

In this case traders are looking at the potential for profitable technical trading as China woes drive the AUD up and down. The divergence trade to sell euro and buy yen is based on central bank driven fundamentals.

Yen

The divergence of monetary policy between the EU and Japan has to do with their struggles against a strong dollar. Seeking Alpha asks how low they can go in relation to both the yen and euro.

The euro is being pressured against the US dollar as a result of quantitative easing in Europe, low-to-negative yields and economic uncertainty.

The Japanese yen is struggling against the US dollar as exports stall and Japan pursues an accommodative monetary policy.

Conditions in both Europe and Japan are propping up the US dollar and making a strong case for low volatility investing and currency hedging.

Japan is experiencing similar outcomes for slightly different reasons. The Japanese economy shows signs of softening and it appears the trade sector is feeling the pain of slower global growth. Japanese exports increased only 0.6% on a year-over-year basis in September, and have decelerated of late.

If the Japanese choose to strengthen the Yen a divergence trade of selling euros and buying yen will be successful.