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USD/JPY: Short covering boost for dollar

Short covering has boosted the US dollar from severely oversold levels ahead of the Jackson Hole Symposium later on this week. The USD/JPY’s four day losing streak looks to have ended, while the EUR/USD has turned flat on the week after giving up Monday’s gains. The GBP/USD, which had already been one of the weakest of the dollar pairs, has fallen to a fresh monthly low. Gold and silver were also struggling today after their recent upsurge. Meanwhile equity markets have bounced back sharply. This is due mainly to the easing of political tensions. “Bargain hunters” have taken advantage of short term oversold conditions to buy stocks, while bearish speculators have evidently abandoned (some of) their positions due to the lack of any significantly negative news. However, it remains to be seen if the rally will hold given the technical damage global indices have already incurred.

But if the dollar rebound continues then the USD/JPY may be among the best pairs to watch for bullish setups, not only because of the dollar itself but also due to the stock market rally which reduces the appeal of the perceived safe haven yen.

Prior to this week, the USD/JPY had formed two bearish-looking price candlestick patterns on its weekly chart, the second of which was a doji with a long wick above key support at 108.85 area. These types of candles usually point to weakness, and in this case a potential breakdown below 108.85 support. However, so far this week, the opposite has happened: the USD/JPY is refusing to go down despite bearish price action. When the market talks, we need to listen. Thus, the natural response could very well be a positive one for the USD/JPY going forward. We may see range expansion to the upside once the USD/JPY establishes a base above this week’s opening price level at 109.35.  With the 110.90 level offering strong resistance over the past three weeks, a cluster of stops is surely now resting above that level. Thus, we may see a short squeeze rally in the days to come as the pool of liquidity above 110.90 attracts price towards it.

That being said, all the bets would be off for the bulls if the USD/JPY were to break below last week’s low at 108.60. In this potential scenario the USD/JPY could fall towards the support levels shown on the chart below, with the most important one being at 1.06.85/95 area – the prior resistance and 61.8% Fibonacci retracement level.

 Source: eSignal and FOREX.com.

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