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What fundamental drivers could reverse the USDJPY up trend, and offer longer term investors a better entry point for new long positions?

The following is a partial summary of conclusions from our fxempire.com analysts' meeting, during which the USDJPY's recent weakness was a hot topic. Many of those who like to play long term trends with long holding periods have been waiting for a pullback so that they can enter new long positions. Is this the time? What fundamental drivers will we need?

USDJPY Trend's Long Term Drivers Intact

This entrenched long term USDJPY trend has the kind of potent, enduring fundamental support that should make one of the safest trends for long term, risk-averse investors to ride. In particular:

· The Fed is slowly but surely tightening its monetary policy for the foreseeable future, which should support a stronger dollar.

· The Bank of Japan is headed in the opposite policy direction, and openly admits it wants a weaker Yen.

· If the aphorism "don't fight the Fed" has worked for investors in recent years, it should work even better now that it's got the BoJ allied with it.

· Even better, you don't even need to trust the central banks intentions. Deeper underlying economic and demographic fundamentals suggest that the US economy should do better over the coming years, and that too implies higher USD interest rates and a continued USDJPY uptrend.

You don't have to take my word for it. Deutsche Bank sees it hitting 115 in 2014. For over a year Kyle Bass of Hayman Capital has been saying the pair will eventually be above 200. Rock-star pundit John Mauldin sees it going to 300 in the coming 10 years, calling it the "trade of the decade."

The USDJPY is currently around 104, so if the consensus is correct, the trend still has a long way to run.

As opposed to the typical day-trading style at which most forex traders lose, this is the kind of trend I encourage even beginners and risk averse investors to watch for "buy the dip" opportunities, as long as they know the critical basics of risk and money management, and the varieties of ways to ride this trend, depending on their circumstances and risk tolerance (see the Introduction, and chapters 5 and 7 in my book for details on the why and how of conservative forex investing or trading).

Entrenched currency trends are generally more stable than those of stocks, because it's harder to reverse the fundamentals of countries than it is for individual companies.

So We Watch For The Pullbacks

No matter how stable a long term trend may be, however, it will have its normal pullbacks to support that offer the lowest risk, highest reward entry points. Therefore we watch for the counter-trends to start so that we can monitor them and enter new USDJPY longs when we see a support level holding and these temporary pullbacks finish.

A big part of anticipating those dips is to understand what conditions need to be in place, and to be watching for them to happen.

The USDJPY is just has had its first two week drop since October, driven mostly by reduced taper expectations that weaken the USD.

Technical Upward Momentum Also Intact

Long term upward momentum remains intact per the chart below.

(click to enlarge)

USDJPY WEEKLY CHART OCTOBER 2012 - PRESENT:10 WEEK EMA DARK BLUE, 20 WEEK EMA YELLOW, 50 WEEK EMA RED, 100 WEEK EMA LIGHT BLUE, 200 WEEK EMA VIOLET, DOUBLE BOLLINGER BANDS NORMAL 2 STANDARD DEVIATIONS GREEN, 1 STANDARD DEVIATION ORANGE

Source: MetaQuotes Software Corp, fxempire.com, thesensibleguidetoforex.com 01 jan 151010

For example:

· The overall slope of the uptrend since October 2012, and since October 2013

· Note the layering of shorter duration EMAs above those of longer duration

· Price is still in its double Bollinger band buy zone (upper green and orange Bollinger bands). For details on how to read and interpret double Bollinger bands, see: 4 RULES FOR USING THE MOST USEFUL TECHNICAL INDICATOR, DOUBLE BOLLINGER BANDS

That said, we at fxempire.com started wondering if the pullback is just a normal retracement or the start of something more. In theory it should just be a temporary thing, given that the BoJ remains in easing mode and the Fed is slowly moving towards tightening, albeit with possible pauses.

So, aside from the current technical resistance around the 105 area, what would it take to reverse the strong USDJPY trend?

The question is always worth asking.

Although traders are supposed to trade in the direction of the prevailing trend (in the relevant time frame in which they trade), we all prefer to get aboard those trends, early, just as we get enough technical and fundamental evidence to justify opening our first, partial position.

They're the lowest risk, highest reward trades, so it pays to invest the time researching and monitoring potential trend reversals. Part of that involves trying to come up with realistic trend reversal scenarios, especially for those trends that look unstoppable, and have thus become expensive, crowded, and thus vulnerable to sudden plunges as the weak hands and newbies flee en masse, often prompted by the well-funded institutions playing head games with the herd for fun and profit.

These newly reversing trends, are the lowest risk entry points because they occur near strong support, which is a relatively long term low or high, depending on whether you're looking to ride and uptrend or a downtrend. If that support breaks below your planned stop loss, you're out long before you incur a material loss.

They're also the highest yielders, because, hey, you got in at the start. Now the only trick is not to exit too quickly. Just set your trailing stop right and that's unlikely. See chapter 5 of my book for a step by step guide on how we identify and execute these low risk high yielders, and chapter 7 for a whole chapter's worth of examples. You can view a detailed overview of these chapters here using the "Look Inside" feature and selecting Table of Contents.

So when my long hours of daily market monitoring (the foundation of these articles designed to save you time and effort) turned up the following (via seekingalpha.com's market currents, global and fx vertical), it got my attention. I paraphrase and expand upon it below.

Although everyone is justifiably bearish on the JPY (NYSEARCA:FXY), including Japan's Prime Minister and central bank head who are intentionally trying to toss the Yen under the bullet train, Morgan Stanley made the case for a "tradable retracement" in dollar/yen back down to ¥98 (from nearly ¥105) this past week.

Morgan Stanley mentioned the following possible catalysts:

A debt-induced slowdown in China or another big trading partner hitting regional growth

  • Something to upset the current complacency in global financial markets.
  • Glitches in Abenomics (Japan PM Abe's reckless desperate final attempt to avert economic collapse bold measures to boost long-term competitiveness by devaluing the Yen to boost exports and raise inflation) fail to devalue the JPY.
  • The BOJ, contrary to expectations, fails to ease and allows the JPY to rise for a while. Another JPY- debasing easing could be months away.

I add the following catalysts (to these of my esteemed and much better paid forex traders and analysts at Morgan Stanley) for a new countertrend in the Yen

  • Markets believe a sustained reduction in the pace of the taper is coming and the USD weakens, as we've seen in recent weeks. This is the most likely scenario.
  • An unanticipated US interest rate spike from expectations that the Fed will accelerate the taper or even tighten policy that leads to a global interest rate spike, scares stock markets and sparks a flight to safe-haven assets and currencies and so sends the JPY higher versus the USD.

NB: The big assumption in this scenario is that the JPY's top rank as a safe-haven currency overrides a growing USD interest rate advantage. That's unlikely but possible. If the dollar's rate advantage outweighs the Yen's safe haven status, then the USDJPY up trend could accelerate. This is the more likely scenario, especially because the USD would not only have the rate advantage, it would also have its appeal as the #2 ranking safe haven currency. See here for details on currency risk rankings and how that influences their behavior.

  • Some other big flight-to-safety event that drives up the JPY. For reasons discussed here and here and in other posts over the past months the most likely event is a new EU solvency concern that threatens to become a systemic risk that crashes markets beyond its point of origin.
  • Other possibilities include a spike in geopolitical tensions that involves Japan. The most likely scenario is a sustained flare-up tension between China and Japan that could directly undermine the JPY despite its usual safe haven status.

If one of these happens, we'd be looking for the USDJPY pair to test to around 98 at least

Those unwilling or unable to trade currency pairs on the spot market can also ride this trend reversal if and when it happens via assorted Yen surrogates or assets that move with it, for example:

  • The Yen's ETF surrogates like FXY or other ETFs that track long or short JPY positions
  • The Nikkei (or its ETF and other surrogates) because the Nikkei tends to move in the opposite direction of the JPY. For more on understanding that relationship and other aspects of intermarket analysis, like the definitions of risk and safe haven assets (the labels are deceptive), their correlations and what can change them, see here.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Source: What Could Reverse The USDJPY Uptrend?