Japanese Yen Talking Points:
- Last week was big with both the Fed and BoJ, and this is the week where we find out how markets are going to digest it all.
- USD/JPY technically set a fresh high after the weekly open but the pair remains mired in the same range that’s been in-place since the early-August NFP report.
- EUR/JPY and GBP/JPY can present additional interest for swing and trend traders, along the lines of what I looked at in the last Japanese Yen Price Action Setups article.
The Yen remains an important piece of the macro puzzle. The carry trade served a few different purposes, and along the way became a global source of leverage for financial markets as traders and funds had the opportunity to borrow cheaply in Japan. And for a Japanese Central Bank looking at both a backdrop of decades of low inflation and even deflation, along with a dwindling population that’s expected to fall dramatically in the decades ahead, there seemed little risk to staying at zero or even negative rates for policy.
And, for a long time, inflation stayed subdued. As US interest rates rose in 2022, a spread developed, where investors could borrow cheaply in Japan and then invest in the US, pocketing the difference between the interest rates of the two economies. The problem at that point was that borrowing funds in Japan meant being long the Yen and for a Central Bank that wasn’t open to rate hikes or keeping pace with other markets, that presented risk. So, traders looking to hedge that risk could sell the Yen and buy another currency, such as the US Dollar, and this is what explains the parabolic move in the USD/JPY pair in 2022 which went alongside US rate hikes.
Fast forward two years and we were finally at a point where the Fed was ready to cut interest rates. The Bank of Japan had remained cautious as they’re often expected to do, but it was last July when US CPI was printing below expectations that markets had the very real fear that the Fed may soon be nearing a rate cut cycle. The pair dropped by more than 2,000 pips as we approached that first rate cut from the Fed in September of last year, and USD/JPY eventually tagged the 140.00 level which remains a massive spot of support in the pair.
Perhaps the more important observation from that event is what happened from July 11th to August 5th, when US stocks were in a swan dive as that global leverage was being taken-out of the market. Thoughts of a softer Fed and looser policy helped to arrest those declines on the morning of August 5th, but only after the VIX index spiked to its third highest level ever, rivaling only the Financial Collapse and Covid.
Something funny happened around that rate cut though. With inflation in the US still well-above the Fed’s target, and the FOMC moving fast to moderate policy, inflation expectations started to build for the future. Treasury yields began to spike-higher, and the US Dollar rallied along with it. And in Q4 we had a strong reversal in the USD and for those still holding on to the carry trade (or hedges to diversify JPY risk from the carry trade), this was a massive sense of relief.
Another episode of fear arrived around the Q2 open this year, and again, both stocks and USD/JPY were in free fall at the time. This was the ‘Liberation Day’ announcement of tariffs, and President Trump seemed to take a hard line at Japan, alleging currency manipulation on the basis of loose policy bringing a weak Yen and a strong Dollar.
It was later in the month when USD/JPY again tagged the 140.00 level and in late-April and May both equities and the pair showed signs of recovery.
While the pair didn’t show a dramatic decline around this year’s rate cut, I think there was something else in the background and that’s the fact that inflation remains high and the prospect of several follow-through rate cuts, despite what markets are pricing in via bond markets, seems more distant than what showed last July and August. As a case in point, USD/JPY has continued to hold with relative strength, well-above the 140.00 low from April or the 142.80 low from July.
And again last week, there was an open door for bears that was quickly rebuffed, with the pair rallying on news of the Fed’s rate cut following a test of key support at the 145.86 level, confluent with the trendline taken from this year’s higher-lows.
USD/JPY Daily Chart
Chart prepared by James Stanley; data derived from Tradingview
USD/JPY Bigger Picture
It’s now been five months since USD/JPY set that low at the 140.00 handle, and during that time DXY has made fresh lows on multiple occasions. This, of course, is driven by other currencies, namely the Euro, which makes up far more of the DXY basket and that pair has been driving to fresh four-year highs as DXY has been selling off.
But – should the data worsen to the point where several rate cuts are expected from the Fed, we could be looking at a repeat of last July’s scenario, or a similar backdrop as what showed in April.
With USD/JPY remaining more than 40% above the early-2021 values that showed before US inflation picked up, it’s reasonable to expect that there’s still impact from the carry trade showing in the pair. And given the now three test of that 140.00 handle, an ultimate break below could be seen as a major event in the pair’s price action backdrop, and perhaps something that highlights a shift in that bigger picture theme. It’s also something that could further cause de-leveraging from risk markets like stocks, such as we saw last year.
USD/JPY Weekly Chart
Chart prepared by James Stanley; data derived from Tradingview
The above weekly chart illustrates the recent range well and can probably be argued as either bullish or bearish, although I currently lean towards the latter. In the bearish camp, price is holding at the 38.2% retracement of the sell-off from last July, and that price has been resistance for the past two months. Bulls still haven’t been able to leave it behind.
But on the bullish side, bears have also been rebuffed and most recently that happened last week. Given the higher-lows of the past five months to go along with that horizontal resistance, an ascending triangle can be argued, and that’s a bullish breakout formation.
With that said, I still remain of the mind that the deductive Yen weakness on the above chart can still set up more attractively against the Euro or British Pound; and until the USD shows more progress towards a breakout, which could certainly happen this week, I’m expecting that to remain the case.
EUR/JPY
In EUR/JPY, it’s all about the 175.00 level. There’s been a dearth of historical tests at that level with just one single day last year showing a close above. That was followed by the July 11th reversal, and price then went down for a test of support more than 2,000 pips away on the morning of August 5th.
More recently, EUR/JPY has been in an ascending triangle that broke-out last week. Friday led into profit taking from that breakout but higher-low support structure has remained in-place, and the pair remains in a bullish state as price didn’t take-out the 173.00 zone.
The 175 handle is now confluent with the 127.2% extension of the July pullback move, and that’s a Fibonacci retracement that produced numerous inflections over the past couple months.
EUR/JPY Daily Chart
Chart prepared by James Stanley; data derived from Tradingview
GBP/JPY
Last week’s profit taking seemed a bit more aggressive in GBP/JPY than the above in EUR/JPY, as the pair still hasn’t shown convincing acceptance of the 200 level. It did break a little bit deeper last week, however, and given the hold at trendline support, there’s still an open door for bulls to make a push here. This one seems a bit less clean than the above in EUR/JPY but also a bit more bullish than what shows in USD/JPY, at this point.
GBP/JPY Daily Price Chart
Chart prepared by James Stanley; data derived from Tradingview
--- written by James Stanley, Senior Strategist
