Yen’s Divergence with Risk Appetite Could Present Opportunity for Traders

USD/JPY

The Yen continues to find support despite a slight rebound in equity markets and the fact that the two have a 65% correlation. I took a shorter term perspective to show the split in price action which could be an opportunity as we can see that the USD/JPY and the Dow had been in lock step during the month prior to the divergence. If their relationship holds then we should either see a retracement in the currency pair or weakness in stocks. Meanwhile, U.S. interest rate expectations have seen their influence on price action wane as the Fed is now expected to remain on hold until the second half of the year which adds weight to the argument that the current divergence will be temporary.

BoJ Interest Rate Expectations

Overnight Index Swaps are pricing in only a 1 bps of tightening from the BoJ over the next twelve months. The central bank is expected to remain on hold until 2011 as deflationary pressures persist. The pace of decline of prices has slowed but continues to trend lower which has led to Japanese fundamentals losing their relevance when determining yen price action. To discuss this and trading ideas join the USD/JPY forum.

FOMC Interest Rate Expectations

Fed funds futures are now pricing in only a 3.7% chance of a rate hike by April which is slightly higher from yesterday following a better than expected US ISM non-manufacturing print. Continued expansion in the service sector bodes well for future growth as it accounts for the majority of U.S. jobs. Increases in the business activity and employment components were encouraging. However, the upcoming Non-farm payroll report will have a considerable impact on the direction of future policy as the lack of job growth has been a barrier for any rate hike. Forecasts are for a decline of 65,000 which will dim any expectations of a change in policy during the first half of the year, which could weigh on the greenback.

Risk

A strong US service sector reading added to the evidence that U.S. economy continues to improve which has helped stocks continue their current uptrend. Taking a closer look at price action we see that a short-term inclining wedge formation warns of a breakout. The upcoming US NFP report could be the catalyst for such a move with upside potential to 10,800. However, a break below leaves support at 10,200 with potential to 10,000. Discuss this and other fundamental data join the Economics Forum.

To discuss this report or be added to the email list contact John Rivera, Currency Analyst: jrivera@fxcm.com