RealMoney Silver - Forget the Fed, Watch the Yen-Dollar Link

Forget the Fed, Watch the Yen-Dollar Link
By Helene Meisler
RealMoney.com Contributor
9/17/2007 9:38 AM EDT

I can't recall another Fed meeting that was so anticipated, so discussed, so picked over. Oh wait, yes I can -- it was the June 2006 meeting, when after a long period of hiking rates the Fed finally lowered rates. Now we have the anticipation of a long period of rate hikes coming to an end.

You might recall how "behind the curve" the Fed was thought to be then. You might recall how everyone hated Chairman Bernanke and company because it was believed they should have cut in May of that year and they did not. Now everyone believes the Fed should have eased in August and they didn't, so we're told they are again behind the curve.

The more things change, the more they stay the same.

The reaction to that June 2006 Fed move was that the market soared. Folks just loved it -- for a few days. Then they hated it and took the market right back down in the first few weeks of July 2006.

What we have as we head into this week's FOMC meeting is a market that is overbought.

We head into this week's FOMC meeting with an overbought market, one that finds the 30-day moving average of the advance/decline line moderately overbought. It will be back to being oversold by Friday. (For more explanation of these indicators, check out The Chartist's primer.)

We also have the members' short ratio back up to 35%. That is by no means a huge reading; something in the 40s would be huge. But you can see on the chart that it has clearly moved up from the lows of 31% a month ago.

Away from those statistics, I have been asked several times why I pay so much attention to the relationship of the U.S. dollar to the Japanese yen. Below is a chart of the CurrencyShares Japanese Yen Trust (FXY) , the ETF for the yen vs. the dollar. As the yen got weaker this past spring, the S&P 500 rose. As the yen began strengthening in June and July, the S&P began weakening.

The Aug. 16 spike up in the yen and subsequent decline coordinated perfectly with the low in the S&P (point A on the chart). Each subsequent short-term decline and rally since then has been accompanied by a move in the yen/dollar relationship.

I have drawn in a blue uptrend line on the chart so you can see that this currency relationship is at a critical point. A breakdown on this chart is likely to come in concert with a breakout in the S&P chart (below). A bounce from the uptrend line will probably mean the S&P is coming back down again.

As I said Friday and have just repeated, my indicators all point to a decline sometime this week, but chatter anticipates a "sell the news" reaction to the Fed meeting. That is confirmed by the fact that the put/call ratio soared on Friday, despite the market having come back from a big down opening that session.

Therefore, I'd say keep your eyes on the dollar/yen relationship. I believe that is the tail that is wagging this dog. Look at the June/July period; you can see how the currency relationship was making higher lows while the S&P was making higher highs; that's not a confirmation of the higher high in the S&P with a lower low in the currency. It led, it did not follow.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider CurrencyShares Japanese Yen Trust to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.