Yen May Face Headwinds as BOJ Curbs Outlook

Includes: FXY, ICI, YCS
by: Cliff Wachtel

Japanese Yen Bias: Bearish

Fundamental Forecast for Japanese Yen: Bearish

  • USDJPY: Worsening Japanese fundamentals, rising risk appetite provide fundamental support for rising trend, 86 is the main resistance zone before further highs can be expected.
  • USDJPY remains firmly in its Bollinger Band Buy Zone (see below), suggest more near term upside once it gets above resistance of its 50 week SMA around 85
  • USDJPY: Try to defer new long entries until pullbacks to ~83.50 area
  • Japanese Yen slips back from a rally founded on renewed earthquake fears
  • Bank of Japan: ¥1 trillion in post-earthquake aid loans – could liquidity drains turn Japan into net US Bond seller?
  • BOJ policy to remain highly accommodative

The Longer Term Technical Picture for the USDJPY

Note the below USDJPY weekly chart (click to enlarge):

ScreenHunter 03 Apr 10 00 31 JPY Weekly Outlook: Risk Appetite, Repatriation Sentiment, Damage Costs


The key takeaway points include:

  • An ongoing break above the 84 zone, which has been resistance since December 2010
  • Price testing key resistance around 85 of the 50 week SMA (red) and upper Bollinger Band
  • Momentum firmly to the upside as price remains in the upper Bollinger Band Buy Zone (area bounded by upper red and blue Bollinger Bands)

The Japanese Yen continued to depreciate in April, with the USD/JPY advancing to a fresh yearly high of 85.51, and the low-yielding currency may face additional headwinds in the coming days as central bank curbs its outlook for future growth.

For now, market participants are scaling back speculation for a huge wave of repatriation as the Bank of Japan increases its efforts to support the economy, and currency traders may continue to push the Yen lower over the near-term as they increase their appetite for risk.

Deteriorating JPY Fundamentals May Also Hurt the USD, EUR, and GBP, Slowing The JPY Decline

However as the costs of the damage continue rising, both from radiation and production cuts, it’s possible that Japan, which has been a huge liquidity exporter to the US (i.e. massive US bond buyer) might become a net seller, with possibly dire consequences for the US. If demand for US bonds drops, that means higher US bond yields, US mortgage yields, and further damage to the key US banking and housing sectors

The same threat holds for other major sellers of sovereign bonds to Japan, like the EU and UK. All three of the major Western economies risk additional hits from as Japanese production slowdowns create similar drops in production elsewhere that depends on Japanese raw materials, parts, or finished goods. These include steel, silicon wafers, machine and car parts, and assorted consumer electronics.

The Bank of Japan said the real economy “is under strong downward pressures” following the slew of natural and nuclear power disasters, and offered JPY 1 trillion in one-year loans bearing a 0.1 percent interest rate in an effort to aid the rebuilding process.

After holding rates steady once again, the central bank pledged to take additional steps to shore up the economy if conditions warrant a further expansion in monetary policy, but expects the region to return to moderate growth once the rebuilding efforts get underway.

With the rise in bearish JPY sentiment and risk appetite, the rise in carry trade interest is likely to exacerbate the weakness in the low-yielding currency, and the USD/JPY may continue to retrace the sharp decline from the previous year as it breaks out of the long-term downward that began in 2007. However, as the relative strength index falls back from overbought territory, there could be a corrective retracement in the coming week, and the dollar-yen may fall back to the 23.6% Fibonacci retracement around 83.70 to test for near-term support as shown on the above chart.

NB: The EURJPY may be a better play on the JPY downtrend, as the ECB begins to raise rates and make the EUR even stronger than the JPY by comparison. Ideally defer new EURJPY longs until we get a retracement to support around the 120 area.

How To Profit

The above suggests that multi-day trends are more likely to be higher than lower, thus odds continue to favor longs EURUS plays over the course of the week

  • Forex Traders: stay long the USDJPY or EURJPY, as noted above
  • ETF Traders: Long on the JPY short ETF, YCS, or carry trade ETF ICI, or short the long JPY ETF, FXY
  • Forex Binary Options Traders: Short the JPY via buying calls on the USDJPY or EURJPY, depending on the technical merits of their charts in your chosen time frame. Note that the above JPY bearishness is over the course of the coming week, and may not be relevant for those trading on hourly or daily time frames, especially if one does not wait for intraday pullbacks to support before entering new long positions.