Increased volatility in the Japanese yen, has traders wondering whether the rules have changed for the safe-haven currency, writes Adam Button.

The Japanese yen’s plunge of the past two days threatens to re-write the rules of trading JPY. We look at the move and the disjointed risk picture it unravels. Stock Indexes are tumbling across the board after high profile failure to follow-through the highs, while gold rises to its highest level relative to S&P 500 in two weeks. Take a look at the historical Gold vs. Japanese yen chart below.  Ashraf asked, “how low would the S&P 500 be today if E-Trade (ETFC) did not rise 24% as a result of Morgan Stanley's (MS) acquisition of the online broker.”

Is Yen-Centric Risk Back? - Gold Yen Feb 20 2020 (Chart 2)

The playbook in yen trading for a generation has been to largely ignore Japanese fundamentals because ultra-low rates even in relatively good times cemented its status as a funding currency. In addition, huge Japanese overseas investments and the tendency to bring them home in times of global uncertainty solidified it as a safe-haven currency.

Is that dual axis breaking down? It's far too early to draw any conclusions but the latest drop in the yen is undoubtedly country-specific. There is some element of risk appetite in play but gold is at seven-year highs and Treasury yields remain a hiccup away from yearly lows.

What changed is a brutal GDP report at the start of the week. The 6.3% annualized drop is breathtaking and while a 3.8% fall because of the sales tax hike was anticipated, that's a much bigger decline. Without annualizing, it's a 1.6% quarterly decline, wiping out all the growth since mid-2017. It was followed up Wednesday by a poor machine tool orders report and the yen breakdown began shortly afterwards.

The message of the market might be twofold:

1) That the Bank of Japan will have to reach deeper into experimental policy. They've already crossed many previously-unthinkable thresholds and every step further risks a dramatic loss of confidence in the currency.

2) The sharp drop in growth in Q3 shows that consumers and the economy can't withstand a tax hike and that raises the risk of an accelerating debt spiral and loss of confidence.

3) Coronavirus is now a consideration. Certainly, Japan is at a higher risk of an immediate outbreak than the United States or Europe but if it travels regionally next, it almost-certainly ensures it will be a global pandemic in weeks or months so the time mismatch shouldn't matter. Some say Japan was betting heavily on the summer Olympics. Could the virus cause visitors to stay away from the Land of the Rising Sun? Even in the best case scenario, the threat would probably create fewer visitors.

4) The yen is no longer the only funding currency. It's not a coincidence that this takes place as the euro and Eurozone yields continue to fall. In many ways – particularly on the deficit side and monetary policy side – the euro makes for a better funding currency. This is something we have been highlighting for months and will be exploring more in the weeks ahead.

Again, we must emphasize that it's far too early to anticipate any kind of structural shift in the FX market. A number of factors are in play including technical breaks and a squeeze above 110.00 in USD/JPY and a breakout from unusually low volatility. A change in regimes isn't going to happen overnight, but we're watching closely.

Is Yen-Centric Risk Back? - Tweet Dax Dow Midnight (Chart 3)

Adam Button is co-owner and managing director of ForexLive.com and a contributor at AshrafLaidi.com. You can see Ashraf’s daily analysis at www.AshrafLaidi.com and sign up for the Premium Insights. Ashraf's Tweet on indices here.