USD/JPY Unwind Accelerates as Suspected Intervention, Fed Hike Doubts Collide

• Suspected MOF intervention drives USD/JPY sharply lower.
• Williams and Waller cool September hike expectations.
• USD/JPY correlation with US yields has surged.
• Payrolls now loom as the key binary risk.

Summary

A combination of suspected intervention from Japan’s Ministry of Finance, coupled with less hawkish remarks from senior FOMC officials that contrast with those delivered by Chair Kevin Warsh at Jackson Hole last Friday, has helped deliver a powerful bearish break in USD/JPY, sending the pair back to the levels seen around the lows of the intervention episode in late July and early August.

Déjà Vu in USD/JPY

If it looks like a duck, acts like a duck, it probably is a duck. And when I look at the price action in USD/JPY on the four-hourly chart ahead of this latest significant unwind, I can’t help but feel it looks almost identical to what we saw just before the intervention episode in late July and early August.

Source: TradingView

USD/JPY had been trading in a shallow uptrend, bouncing along it, before entering a period of consolidation. Then, whooshka, a huge move lower out of nowhere, coinciding with hawkish talk from Japanese officials earlier this week about potentially speeding up the pace of rate hikes.

But I can’t get on board with the idea that this was the only factor behind the move, particularly as the remarks came from Hajime Takata, who is already the most hawkish official at the BOJ. Instead, the magnitude and abruptness have all the hallmarks of BOJ intervention of the past.

Source: Bloomberg, FOREX.com

Another Day in the Window

And if my hunch is right, it points to the potential for additional intervention on Friday. Under the IMF’s classification framework, a currency can retain its free-floating status provided intervention is exceptional and limited to no more than three instances over the previous six months, with each instance lasting no more than three business days.

So if Wednesday marked the start of another intervention episode, Japanese authorities would still have scope to be active again on Friday without breaching that three-business-day threshold. That doesn’t mean they will, but it certainly leaves the door open for the MOF to really ram home the message before the week is out.

And honestly, it would send a powerful message if they did. It would underline just how dissatisfied Japanese authorities are with what’s been going on in the yen, particularly because they now have a window where US economic data has started to soften and senior Fed officials have sounded more dovish, or at least less hawkish, than markets had been priced for.

Fed Messaging Splinters

Assisting the bearish unwind, we’ve also seen notable and quite conflicting messages from some of the Fed’s most senior officials compared with the tone struck by Chair Kevin Warsh at Jackson Hole last Friday.

While Warsh stopped short of explicitly endorsing a September hike, fitting with his previous reluctance to provide forward guidance, he made it clear he remained dissatisfied with inflation staying too high, warning that if that continued, “the Fed has work to do”.

Speaking on Wednesday, New York Fed President John Williams said the case for a September hike “isn’t yet firm”. Less than 24 hours later, influential Governor Christopher Waller said he would support keeping rates unchanged in September if August inflation data out next week continued to cool.

US Rates Connection Tightens

Those comments helped deliver a substantial unwind in hawkish Fed pricing, dragging US Treasury yields lower across the curve despite very firm ISM services data released during the session and a big gain in crude oil, two factors that would normally be expected to boost USD/JPY.

Source: TradingView, FOREX.com

And the move in US yields matters. Over recent sessions, USD/JPY has re-established a very tight positive relationship with outright Treasury yields, far stronger than comparative yield spreads between the US and Japan over identical timeframes. The five-day correlation with the US 2-year yield has risen to 0.87, while the relationship with the US 10-year sits at an even stronger 0.99.

Source: TradingView, FOREX.com

So while suspected Japanese intervention may have provided the initial shove lower, the subsequent move in US rates has provided plenty of fundamental backing for the unwind.

Key Levels After the Break

From a technical perspective, the latest unwind from above 160 has taken USD/JPY back into a zone where strong bids have emerged on two separate occasions this year, first in early May and again in early August. And once again, we’re seeing a similar response, with the pair rebounding from beneath 155.50 back above 156.

What happens with that rebound will be important. During the intervention episode in late July and early August, USD/JPY repeatedly staged abrupt rallies before another wave of selling kicked in and pushed the pair even lower. If we see the same playbook again, 156.68, the swing low set on August 7, and then 158 are the first levels I’d be watching overhead. The latter has acted as both support and resistance at various points this year.

On the downside, if this is another intervention episode and Japanese authorities really want to ram home the message, 154 is the next level I’d be watching. That zone acted as both support and resistance back in January and February. Beneath that, 151 stands out as another major level given how often it has acted as both support and resistance over a much longer period.

Payrolls Could Blow This Wide Open

Adding a major complication to positioning for possible continued intervention, we have a significant binary risk event looming on the horizon in the form of August non-farm payrolls later in the session.

On the surface, the report may not appear as significant as it has in the past. Warsh made it clear at Jackson Hole that he was satisfied the labour market remained stable, suggesting inflation was the more immediate concern for the Fed. But with two senior FOMC officials subsequently introducing a more disinflationary tone, maybe the labour market isn’t quite as secondary a consideration as many first imagined.

Only a very modest increase of around 55,000 in non-farm payrolls is expected. And August has a reputation for delivering downside payroll surprises. If that tendency were to show up again on this occasion, it could conceivably produce a second consecutive negative payrolls print.

That would be significant given the Fed has never hiked rates immediately after two consecutive negative payrolls prints. Ever.

Then there’s the unemployment rate, arguably the more important measure of labour market conditions right now. As discussed in our week-ahead note last weekend, the participation rate has now gone an unusually long period without an increase, helping suppress the unemployment rate despite very weak hiring.

That doesn’t mean participation has to rise in August. But probability suggests it can’t keep moving in the same direction forever. If participation does finally lift without a commensurate increase in employment in the household survey, that too could create upside risk for the unemployment rate, adding another potential source of dovish Fed repricing.

For USD/JPY, payrolls has the potential to turn this bearish unwind into a big boppa, or spark a savage reversal if the data comes in materially stronger than expected.