USD/CHF, USD/JPY: Dollar Rebound Risk Builds as Oversold Signals Flash

• USD/CHF and USD/JPY hit fresh lows last week before stalling on Monday
• Oversold momentum signals and stabilising yields flag squeeze risk
• USD/CHF eyes potential morning star reversal after doji candle
• USD/JPY holding above key support near 142.00 with rebound potential

Summary

It’s been well documented that higher U.S. Treasury yields are no longer providing a boost to the U.S. dollar by encouraging capital inflows from abroad. Instead, they’re increasingly being seen as evidence of potential capital flight from U.S. dollar assets into other currencies. Rather than being treated as a safe haven, the dollar has traded more like an emerging market currency over the past week.

The Swiss franc and Japanese yen have been major benefactors of the changing risk landscape, with USD/CHF and USD/JPY tumbling to fresh lows, taking out key technical support levels in the process.

However, with signs of stability emerging in U.S. Treasury markets on Monday—and with the Swissie and yen either overbought or nearing overbought against the dollar—there appears to be a growing risk of some form of near-term countertrend squeeze.

Treasury Rout Over?

U.S. 10-year note futures offer some insight into just how wild moves in benchmark Treasuries have been over the past fortnight, hitting their highest level since early October only to reverse sharply on the back of enormous volumes, plumbing lows not seen in several months. Remembering that Treasury prices move inversely to yields, the latter dipped sharply before ripping higher by 50bps, logging the largest one-week increase since 2001.

Source: Refinitiv

It’s little wonder the dollar came under pressure, with benchmark yields for the largest and most liquid bond market in the world—only recently considered the ultimate safe haven—flailing around like a windsock on a gusty day.

While the improvement may prove fleeting, the price action over the past day has been far more pleasant for U.S. dollar bulls. A big bounce in Treasury futures facilitated the largest one-day drop in 10-year yields so far this year. Even though the signal may not be overly reliable given the headline-driven nature of markets right now, the momentum picture is starting to look far less dire for Treasury futures, with RSI (14) breaking its downtrend and sitting near neutral territory. While MACD continues to trend lower, it sits only marginally in negative territory.

Source: TradingView

Under normal circumstances, signs that Treasury yields have topped may see the U.S. dollar soften against other major currencies—especially those with historically tight relationships to interest rate differentials, such as USD/JPY and USD/CHF. However, with the relationship between the dollar and Treasury yields temporarily flipped on its head, lower yields may actually benefit the dollar in this instance. 

USD/CHF Unwind Stalls

You can see how violent the downside move in USD/CHF was last week by the size of the bearish candle that printed on Thursday, taking out the December 2023 swing low before extending the move on Friday. Momentum indicators remain bearish, with RSI (14) and MACD deeply negative and continuing to trend lower.

Source: TradingView

However, while the momentum signal favours downside, it’s notable that USD/CHF was unable to extend the bearish move on Monday despite widespread USD weakness. The tombstone doji that printed for the session—following Friday’s bearish candle—puts added emphasis on Tuesday’s price action, especially if a decent squeeze higher were to occur. That could complete a three-candle morning star pattern, often regarded as a bottoming formation. With RSI (14) in very oversold territory, conditions for a squeeze are in place.

Those looking for a countertrend move could consider buying around these levels with a stop beneath 0.8100 for protection. In each of the past two sessions, USD/CHF ran into sellers around 0.8260, suggesting that level could be an initial target. Beyond that, the December 2023 low of 0.8333 is another possibility. If the price resumes its unwind and takes out 0.8100, the bullish setup would be invalidated.

USD/JPY Buyers Lurking Above 142

USD/JPY sits in a similar position to USD/CHF, although it hasn’t yet reached the same extreme oversold conditions. However, having failed to breach 142.00 in each of the past two sessions, it generates a setup where longs could be established ahead of the level with a stop beneath to protect against a resumption of the bearish trend. Ideally, entry would be closer to the recent lows to improve the setup's risk-reward. 

Source: TradingView

144.00 screens as a logical initial target, with a break beyond that opening the path for a potential move back towards resistance at 148.15. RSI (14) and MACD continue to provide bearish momentum signals, favouring downside over upside. While that suggests a meaningful bullish move may prove difficult in the near term, it doesn’t mean it’s impossible.

-- Written by David Scutt

Follow David on Twitter @scutty