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The decline from 101.50 remains beneath channel resistance (when treating the early August spike as an outlier) but the decline could be complete. Price remains above the December 2008 low of 87.10 and the decline from 101.50 is choppy, therefore one must consider the possibility that the drop is corrective. It is possible that a triangle or flat pattern is underway from 87.10. Under both scenarios, most of the decline from 101.50 would be retraced. Trading above 92.35 would signal a breakout and long opportunity.
Interest rate traders forecast that the US Dollar yield advantage over the Japanese Yen will pick up significantly in the coming 12 months, but recently apathetic FX speculators have shown little interest in interest rate developments. The US Dollar/Japanese Yen exchange rate has instead moved off of shifts in global financial risk sentiment—especially as seen through key risk barometers such as the S&P 500 and Nikkei 225 indices. We predict this will continue to be the case through the foreseeable future.
Indeed, Overnight Index Swap differentials have supported a USDJPY rally since the pair traded near the 105 mark. Suffice it to say, such interest rate-based forecasts were far from accurate. It remains far more important to monitor general financial market risk sentiment.
Japanese Yen positioning is little changed from the previous month. Comparatively speaking, the currency is the least overvalued against the greenback among the majors and prices still have a long way to go before reaching the kind of extremes that would suggest that a correction may be imminent. USDJPY remains over 81% correlated with the yield on 10-year US Treasury bonds and the need to finance the States’ hefty budget deficit through debt issuance suggests that yields will push higher in the weeks and months ahead, dragging the pair higher. On the other hand, equities are starting to show signs of ebbing momentum, with the onset of another bout of risk aversion likely to weigh on carry trades and boost the Yen. The latter is likely to be a more immediate catalyst, so it seems that the Yen will head further into overvalued territory before a meaningful correction is realized.
What is Purchasing Power Parity?
One of the oldest and most basic fundamental approaches to determining the “fair” exchange rate of one currency to another relies on the concept of Purchasing Power Parity. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. For example, if a pencil costs €1 in Europe and $1.20 in the US, the “fair” EURUSD exchange rate should be 1.20. For our purposes, we will use the PPP values provided annually by Bloomberg. We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar.
Written by Ilya Spivak, Currency Analyst; David Rodríguez, Quantitative Strategist; Jamie Saettele, Senior Technical Strategist for DailyFX.com
DailyFX provides forex news on the economic reports and political events that influence the currency market.
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