USDJPY poised to break higher

The news that the market has been holding its breath for the past week was finally delivered this morning. Effective from September 24^th, the U.S. Government will implement a 10% tariff on approximately U.S. $200 billion worth of Chinese imports, rising to 25% next year. Ominously, the U.S. have repeated their intention to implement tariffs on a further U.S. $267 billion of Chinese imports should the Chinese retaliate. Based on past statements, Chinese retaliatory tariffs on $60 billion of U.S. imports appears likely.

The initial reaction to the announcement was a brief period of “risk-off”, with the S&P500 falling from around 2895 back to trend channel support 2880 area. While in currency land, the G10 proxy for all things China, the AUDUSD fell from .7180 to .7145. Both have since recovered much of their early losses partly because this morning’s announcement removes a layer of geopolitical uncertainty from the market for the time being.

Furthermore, as discussed in this article last week https://www.cityindex.com.au/market-analysis/eurchf-and-italy/ the market is becoming more comfortable with the idea that the short-term hit to economic growth both in China and in the U.S. due to tariff implementation is not as great as initially feared. The real damage is likely to take longer to show up as business investment decisions are deferred or cancelled and supply chains distorted.

There is good reason to think that the booming U.S. economy is well placed to withstand the impact of international concerns after another formerly reliable dove and FOMC voter, Federal Governor Lael Brainard, warned in a speech last week that interest rates might need to rise beyond the neutral level if conditions warranted it. Interest rate markets have taken heed of Brainard’s warning with the yield on 10-year Treasury’s now up against resistance as shown in the chart below. A break and close above 3.02%/3.05% in yields would suggest a further rise towards the 3.13% high from May of this year, before a move to 3.30%.

As a reminder, U.S. 10-year Treasury yields are an important driver of USDJPY as can be viewed on the chart below.

Therefore, should U.S. 10-year yields break and close above 3.05%, it should prove to be the catalyst for USDJPY to retest the 113.17 high from mid-July, before a move up to the 114.50 area.

In terms of trading this view and to keep it simple, I will assume that both U.S. yields and USDJPY should break higher in tandem. Therefore, I will look to go long USDJPY on a stop entry at 112.31. The stop loss for the long USDJPY trade will be placed at 111.55. The first upside target to sell 1/3 of the long position will be at 113.10. The second and final upside target will be 114.50. As always, if the trade runs in the anticipated direction, I will look to trail my stop loss higher with a move to 113.10, allowing me to raise the stop loss to 111.99.

Source Tradingview. The figures stated are as of the 8th of August 2018.  Past performance is not a reliable indicator of future performance.  This report does not contain and is not to be taken as containing any financial product advice or financial product recommendation

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