CHF/JPY waterfall meets a history of counter-trend squeezes

• CHF/JPY downside stretch hits most extreme levels since 2018
• Prior extreme episodes favoured stronger forward returns
• Hawkish BOJ repricing, record intervention and US support bolster yen
• Long-term support near 188.80 key for any bounce

Waterfall mode

CHF/JPY has gone into something akin to waterfall mode over the past week or so, something of a rare occurrence considering just how respectful the pair has been of known technical levels, as demonstrated on the chart below.

That’s pushed Swissy-yen into extreme oversold territory on the downside, with the ATR 50 stretch and RSI (14) both now at the most extreme readings seen in the daily sample going back to mid-2018.

Source: TradingView

Stretch reaches historic extremes

Using daily data going back to June 2018, there have been six completed episodes where the ATR 50 stretch indicator in the bottom pane has fallen beneath -2.5, while RSI (14) was below 30, with both indicators pushing lower into the signal.

While backtesting suggests the initial results were mixed, with Swissy-yen higher only four times out of six one session later, the further out you go, the stronger the historical bias becomes towards a rebound. Five of the six episodes were followed by a higher price three and five trading days later, while all six were higher after 10 and 20 sessions. The average gain was around 1.2% after 10 days and 2.2% after 20.

Source: TradingView

While past performance is not indicative of future returns and does not guarantee the same outcome on this occasion, the current setup is considerably more extreme than any of the thresholds used in that backtest, underlining just how extreme this move has been.

Hawkish BOJ repricing strengthens yen

From a fundamental perspective, the yen has had a lot of positives working for it recently, one of which has been a significant hawkish repricing of Japan’s interest rate outlook, as seen in the graphic below.

The implied overnight rate for next Friday’s BOJ meeting has risen from 1.15% at the start of September to 1.24% today, taking pricing for a 25bp hike from around 70% just over a week ago to slightly more than a full quarter-point move.

Further out, markets are now pricing around 3.7 hikes by July next year, up from just over 3.2 at the start of the month.

Source: Bloomberg

Bessent turns the hubris up

Another factor has been an unusually high level of support from the United States for efforts to strengthen the yen. Alongside the ongoing threat of intervention from Japanese authorities, US Treasury Secretary Scott Bessent has expressed extraordinary confidence that policymakers will ultimately get their way, with the level of hubris in his recent remarks almost off the Richter scale.

Bessent had previously said he possessed “asymmetric information” regarding what Japanese policymakers were likely to do. This week, he went a step further, declaring “I am the house now”, saying that when the US and Japan intervened in the yen he had “pretty good insight” into what the BOJ and Japanese policymakers were going to do, before telling traders: “You can bet against me if you want.”

Those extraordinary remarks come after data released this week showed Japanese authorities spent ¥15.39 trillion on yen-buying intervention between late July and late August, the largest amount on record.

When you look at that, it’s understandable why the yen has been so strong recently. But the honest assessment is that it’s still subject to some of the same macro headwinds from energy insecurity and deteriorating terms of trade from high energy prices. As such, you need to ask what else is left out there that can really benefit the yen from here, at least in the short term.

US inflation keeps yen volatility alive

Looking ahead, there is little in the way of major economic data due in either Japan or Switzerland between now and next Friday’s BOJ interest rate decision, providing a relatively clear domestic calendar over the coming week.

However, that doesn’t mean the pair has no looming catalyst that could spark significant volatility, with US PPI out later today and CPI tomorrow carrying the potential to significantly shift the US rates outlook, which in turn could have a meaningful impact on USD/JPY and broader yen volatility.

While most of G10 FX has been as quiet as a church mouse over the past month, the yen has been notably more volatile, while the Swissy has also been relatively active, albeit not to extreme levels.

Bounce risk versus prevailing trend

Discussing long setups here goes entirely against the prevailing trend. While history suggests stretches this extreme have often arrived before counter-trend rallies, I’m not interested in trying to pre-empt a similar outcome yet.

While the oscillators sit at extreme levels, they still indicate downside momentum is building, which would normally favour selling into strength, especially over a longer-term time horizon. The medium and longer-term moving averages are rolling over. The 50-day is sloping lower, so is the 100-day, while the 200-day is now showing signs of joining them, with the shorter averages also crossing beneath it.

Of course, that doesn’t rule out the potential for a counter-trend bounce. But before considering playing for one, I’d be looking first for some form of bottoming signal, whether on the daily chart or on a shorter timeframe such as the hourly or four-hourly.

On the downside, the key area is the intersection of the long-running uptrend dating back to September 2021 with horizontal support around 188.80, a minor level that also acted as support in October last year. That is the support zone I’m watching most closely.

For those looking to play a bounce, a stop could potentially be set beneath that area, while the September 8 low just ahead of 189 provides another nearby reference point depending on entry level and risk tolerance.

If a bottoming signal does emerge, upside levels of note include 190.54, which acted as both support and resistance late last year, then 192.70 and 194.57. Looking much higher than that feels ambitious in the near term.

Of course, if the September 2021 uptrend and horizontal support at 188.80 buckle, that may embolden more bears to join the move. In that scenario, 187.58, which was a breakout level in September last year, followed by 186 and 184, become the next downside levels of note.