Understanding Why EUR/JPY Hit a Record High

Although it has been relatively quiet in the foreign exchange market today, the Euro hit a record high against the Japanese Yen. The primary reason why EUR/JPY has rallied 11 percent over the past 3.5 months is because of US growth - not many people realize that the price action of EUR/JPY is directly correlated with how the US economy is doing.

According to the following chart, there is a strong correlation between manufacturing ISM and EUR/JPY. The arrows on the chart point to the times when manufacturing ISM had a meaningful dip below the 50 boom / bust level. This has happened more than 7 times over the past 20 years. Each time the US manufacturing sector contracted, EUR/JPY rallied. On average, from the month that ISM contracted to the month that ISM moved back above 50, EUR/JPY rallied 314 pips.

The drop in leading indicators last month indicates that the US economy is still in trouble. The rally in the stock market is running out of steam as oil prices begin to rebound. If the US economy and in particular, the manufacturing sector continues to slip, EUR/JPY could not only break 170 but possibly hit 175 before the end of the year.