The Yen May Be the Best Indicator at Deciphering Yellen's Tone

NEW YORK (TheStreet) -- As investors await Janet Yellen's comments at the Federal Reserve's annual symposium in Jackson Hole, Wyo., it could be currency fluctuations overseas that tell the most about the future direction of U.S. equities.

Investors are looking to a statement from Yellen, the Fed's chairwoman, for clues about whether the Fed will continue to keep interest rates low as the U.S. economy gradually improves.

Analysts, however, tend to have a difficult time coming to a consensus on whether comments from the Fed lean more dovish or hawkish, unless specific language is used.

Investors may be better suited looking at movements in the U.S. dollar/Japanese yen currency pair following Yellen's comments to gauge the market's reaction.

The U.S. dollar/Japanese yen currency pair, represented by the CurrencyShares Japanese Yen Trust ETF (FXY) , has held a strong negative correlation with SPDR S&P 500 (SPY) during the past five years.

The yen is perceived as a safe-haven currency as it tends to be bid higher during times of economic uncertainty.

Moreover, many investors have difficulty interpreting the price swings in iPath S&P 500 VIX ST Futures ETN (VXX) because it is perceived as a flawed indicator of risk. And so the yen is often seen as a better gauge of global risk sentiment.

As seen in the chart below, periods of big declines in the yen usually set the tone for broader moves higher in U.S. equities.

The yen fell by more than 24% in the final months of 2012 and by more than 7% in 2013. More accommodating monetary policy on behalf of the Bank of Japan was part of the reason, and so was less investor anxiety.

As the yen declined, the Standard's & Poor's 500 Index rose by 13% in 2012 and 6% in 2013.

 

FXY Chart
FXY data by YCharts

 

This year, the yen has traded in a fairly tight range as fear that U.S. equities were on the verge of a correction has also kept a bid in the safe-haven yen.

Recently, however, the yen has begun to depreciate against the dollar. The Fed minutes, released Wednesday, showed that policymakers are becoming more bullish on the U.S. economy, but believe that rates needed to stay low for now. That led to a flow of funds into the dollar and out of the yen.

If investors like what Yellen has to say on Friday, they will more than likely continue to push the yen lower, leading the S&P 500, SPDR Dow Jones Industrial Average (DIA) and PowerShares (QQQ) to record highs.

 

Chart provided by StockCharts.com

 

At the time of publication, the author held no positions in any of the funds mentioned.

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This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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