Are Risk Markets About to Rally with the DXY? The Yen Offers a Clue

Typically, a rising US Dollar Index (DXY) puts pressure on risk assets, with dollar strength historically moving inversely to global liquidity.

While the broader trend for the DXY remains down, current technicals suggest we may be entering a countertrend rally.

At first glance, this would imply renewed headwinds for risk markets. However, a closer look reveals that much of the DXY’s expected strength is coming from gains against the Japanese Yen, which comprises 13.6% of the index.

As the USD strengthens against the JPY, it sets the stage for an increase in yen carry trades—borrowing in low-yielding yen to invest in higher-yielding USD assets. This dynamic has become increasingly influential since the US began hiking rates in March 2022, widening the yield gap between the two economies.

This divergence has made the yen carry trade a notable driver of liquidity in the current cycle, which began in late 2022. A sharp example came in July 2024, when the Bank of Japan’s surprise rate hike triggered a rapid unwind of yen carry trades and a sharp correction in risk assets.

During this cycle, JPY strength has consistently aligned with risk-off sentiment. Conversely, a rally in USDJPY has seen both the DXY and risk assets—particularly the Nasdaq—move higher in tandem.

At present, USDJPY is poised to break through a key resistance level, potentially accelerating alongside the DXY’s countertrend move. 

This breakout could ignite a euphoric push in risk markets, fuelled by renewed carry trade flows. 

It’s a timely reminder that the DXY isn’t always a reliable inverse indicator for risk. October could defy the usual correlations—delivering gains for both the dollar and risk assets, and living up to the “Uptober” moniker in full.