Recent Yen Strength Is A Bull Trap

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Includes: FXY
by: Options Markets

Summary

Yen strength is based on safe haven buying, not macro fundamentals.

Stalling regional growth makes it difficult for BoJ to accept higher currency valuations.

Changing interest rate differentials should give rise to yen-negative carry trades.

Currency markets have seen a recent divergence from the longer-term trends that have marked most of the last five years. Relative chaos in stock markets has inspired a new round of risk aversion that has led to surging valuations in the Japanese yen. Evidence for this can be seen in the most commonly traded currency pair denominated in yen, which is the USD/JPY. Price levels in the USD/JPY have fallen to their lowest levels since November of 2014, and this has led some traders to question whether we are in for a major bull run in the Japanese currency.

But when we combine the fundamental backdrop with the longer-term trend activity, these latest moves are looking much more like a bull trap than a truly positive reversal - and this is something that should create some level of caution in traders that are looking to get involved with forex pairs like the USD/JPY or the AUD/JPY.

Chart View: USD/JPY

Source: FiboGroup

In this chart, we can see that the declines in the USD/JPY show a close resemblance to assets like the SPDR S&P 500 Trust ETF (NYSE: SPY), which tracks the value of the world's most commonly traded stock index. This should not be viewed as a coincidence, as markets are moving away from higher-yielding assets in the current short-term market climate.

But the real question here is whether or not this strengthen in the yen has reached an exhaustion point. Macro data in the region show very little to get excited about, and relatively growth rates in Japan remain at low levels comparatively.

In addition to this, the Bank of Japan has already expressed concern with the value of the currency. It should be remembered that Japan is an export economy, and higher currency valuations would suppress long-term growth prospects in ways that are even worse than what the country is already experiencing.

Potential For Carry Trade Resurgence

If this is not enough of a reason to avoid bullish positions in the yen, we must also consider the fact that a climate of rising interest rates will put the focus back on carry trading strategies. Remember, carry trades benefit from interest rate differentials in addition to fluctuations in the exchange rate, so macro trends in the US dollar clearly favor the greenback for those taking a longer-term view.

All of this points to a strong potential for turnaround in currency pairs like the USD/JPY. As long as the Federal Reserve maintains its hawkish stance, declines in forex pairs like the USD/JPY will be temporary and should be viewed as an opportunity to start buying with both hands. Essentially, the current environment suggests a bull trap is developing for those with long positions in the yen - and these positions should be trimmed back if not closed completely. In other words, the USD/JPY will close the month at levels higher than we are seeing right now.

Disclosure: I/we 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.