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Is USDJPY Set For A Temporary Bounce?

On September 1st, Brazilian central bankers cut the benchmark Selic rate by 50 basis points, lowering the rate to 12%.  A surprise to the markets, the decision comes as policymakers are growing increasingly concerned about the country’s pace of growth, and not its rising prices.  Inflation continues to remain relatively high in Brazil, just under 7% since the last monthly report, while growth has only risen by 4.2%.  But, can we expect this same type of policy for additional economies that previously showed rapid rates of growth and inflation in the past year?

The concern revolves around other countries that have benefited from solid export demand – despite a slowing of the global economy over the last two years.  Countries like China, South Korea and Thailand have all embarked on restrictive monetary policies in recent months, hoping to stem consumer prices that have soared.  According to recent reports, South Korean inflation continued higher in August 2011 – rising by 5.3% after a 4.7% increase in July.

A good reason for the negative sentiment towards growth has been massive declines in industrial output.  With manufacturing a foundation of growth for most of these economies, it’s not hard to see why economic growth could fall further.  In fact, manufacturing activity in the region has dropped across the board – leaving some in contraction, rather than expansion.

According to the most recent manufacturing report by China Federation of Logistics and Purchasing, manufacturing activity in China dropped to an almost 2 1/2 year low of 50.9.  This is barely above the 50 reading to be considered good for the economy.  Other economies like South Korea and Taiwan – two major exporting centers – have seen their index readings fall to below 50.

Index findings like these are helping to support market theories that these countries will begin to signal an end to their respective rate hike phases.  In the case of China, plans for increased reserve ratios and further yuan appreciation will likely be pulled back.

This will positively affect the USDJPY currency.  Why?

Used as a proxy for growth or restrictive monetary policy in the region, the Japanese yen has appreciated greatly over the last several months – in lockstep with more exotic currencies.  This could reverse as traders begin to rethink the growth and interest rate cycles of the region’s economies.

Now, I’m not saying that a full reversal is on its way.  But, the backlash against Asian currencies, like the Korean won or USDKRW, could produce a medium term correction in the USDJPY currency pair.

The technical picture seems to be supporting this scenario.  Since the Bank of Japan threatened further intervention in the markets back in the beginning of August – followed by the election of Prime Minister Noda – the USDJPY pair has meandered on technical support levels at 76.40.  The longer the currency remains at this level, the higher the chances that the USDJPY exchange rate will advance.  Even better, additional analysis shows that the currency pair could rebound back to as high as 79.00 in the short term.

Source:  FXAlliance Charts

As disappointing as recent manufacturing reports have been, traders will likely be keeping an eye out for more evidence.  Should that evidence arrive, keep an eye out on the USDJPY currency pair.