Strength or weakness in the Japanese yen is of interest not only to Forex traders but also traders in equity markets. The USD/JPY currency pair is especially relevant for U.S. equity markets.
While divergences occur from time to time, the USD/JPY pair typically guides the future direction of products such as the SPDR S&P 500 ETF Trust (SPY) and the Invesco QQQ Trust (QQQ). The chart below helps to illustrate the relationship.
(The chart above, in addition to all other charts proceeding hereafter, was created by the author using TradingView.com charting tools).
The blue line represents QQQ, while the amber line represents SPY. The daily candlesticks represent the USD/JPY pair. While it does require somewhat of a keen eye much of the time, it is possible upon close inspection to find that USD/JPY does have predictive ability; when USD/JPY is bullish, stocks are likely to find some support, whereas stocks tend to face difficulty when USD/JPY pulls back measurably.
It is possible to trade USD/JPY "directly" using a Forex broker; however, it is also possible to buy shares in the ETF product known as the Invesco CurrencyShares Japanese Yen Trust (FXY). As you can see, FXY follows JPY/USD (that is, JPY in USD terms, rather than USD in JPY terms) almost perfectly:
In any case, it is useful monitoring USD/JPY for the broader implications it can provide us with. Since U.S. stocks are still struggling to rebound, moves in USD/JPY will be important for the week ahead.
The chart below shows USD/JPY on a daily basis.
In the chart above I draw attention to two levels with the black horizontal lines: 114.368 and 108.130. The 114.368 level is the level that has already been met six times since February 2017. Each time the USD/JPY pair dropped shortly thereafter. And on every occasion that this occurred without a prompt retest of beyond this level, the pair dropped back down, either to as far as the 108.130 level, or at least below 109.000.
That is not to say that the drop from around the 114.368 level (or slightly higher) has not had its positive retracements, just like the positive retracement USD/JPY has recently demonstrated. But it does mean that still the bias here is to the downside on a longer-term basis. Of course, the above price-level relationship could break, but it is important to note that a bullish USD/JPY would require this longer-term dynamic to break down.
Isn't it interesting also that FXY (the JPY-to-USD ETF product) dropped precisely to the 83.54 level (as depicted in the chart below) before bouncing:
That bottoming at 83.54 precisely matched the longer-term low set back in March 2017, as illustrated by the horizontal black line at this level. Just as I explained before with USD/JPY, and its aversion to retesting and/or conquering the 114.368 level, FXY (which is basically an instrument for trading JPY/USD - the reverse of USD/JPY) appears to have an aversion to retesting and/or breaking longer-term or medium-term lows.
Now we have this longer-term context, the four-hourly chart for USD/JPY below can provide us with a closer look (more useful for predicting the week ahead).
As you can see, the 112.648 level (see the upper black line) now appears to be a new level of resistance for the USD/JPY pair, a level that it appears to be struggling to break. Next week, this level is likely to be tested again, perhaps more than once, early on in the week. This may coincide with a (perhaps modestly) bullish environment for U.S. equities.
If the pair is able to break the level early on, this could provide U.S. equities with even more tailwind, and this 112.648 level might even provide USD/JPY with a new support level upon a negative retracement.
However, another failure at this level could send the pair back down to 112.000, which is proving to be a strong level of support. This is also likely a "psychological level"; a round number, with an apparently evidently strong level of bullish liquidity. A retest of this level would likely result in another bounce first, even if there is ultimately a break to the downside.
However, the base case is likely to involve a retest of 112.648 first, early on in the week commencing October 21, 2018. If the level is broken, watch for the 112.648 level (or thereabouts) becoming an area of support. This could provide U.S. equities (e.g. SPY and QQQ) with some real tailwind, supporting a recovery to the upside.
If however the 112.648 level is hit and then rejected, or even worse if USD/JPY heads back down to the 112.000 level without considering another retest of 112.648, this could signal the potential for another pullback in U.S. equities.
In terms of FXY then, if USD/JPY breaks 112.648 and manages to stay above in the first half of the week, FXY is likely to suffer (FXY basically being the reverse trade of USD/JPY). If USD/JPY however fails to breach 112.648 sustainably, or even fails to retest this level, this would signal near-term (and possibly even medium-term) upside for the FXY product.
USD/JPY is important for stocks, as it is a positive-carry funding currency, while the Japanese yen serves as a safe-haven currency (bullishness signaling risk-off activity, which is typically a bearish signal for stocks).
The longer-term bias here, per USD/JPY's history with the 114.368 (and above) area, remains to the downside (or upside for FXY) over the medium and long term. However, given the positive-carry of the USD/JPY pair, there is an inherent bias to the upside (or downside for FXY) provided sufficient global risk-on activity.
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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.