Broad Based USD Demand Could Start to Weigh on Yen

FUNDYS

It has been very difficult to gauge what the mood and reaction of the markets will be towards the US Dollar on domestic economic data releases. Over the past few months, we have seen a departure from the buy the USD on bad data due to its safe-haven appeal, with sentiment shifting to a net bearish USD outlook even on bad news with market participants feeling more confident in the broader global economic prospects despite the struggling US economy. However, in more recent trade, we have once again seen a shift back to buying the buck on bad local data, with risk aversion escalating dramatically. So how can we break this down and better understand where the USD will go over the coming days and weeks?

Relative Performance Versus USD on Friday (As of 5:00GMT)

1. YEN+0.04%
2. CAD-0.12%
3. SWISSIE-0.15%
4. EURO-0.30%
5. AUSSIE-0.38%
6. KIWI-0.40%
7. STERLING-0.44%

In our opinion, any sign of a softer US economy, but one that is still showing steady signs of improvement will start to weigh on the USD, with market participants feeling comfortable that things aren’t totally out of control and therefore inclined to take on risk abroad through the purchasing of some of the higher yielding currencies. But, any signs of a serious deterioration within local data should ultimately put the balance back in favor of the Greenback, with investors fearing the worst for the US economy and even worse than that for the global economy due to the potential ripple effect (we saw a strong round of European data on Thursday that saw little to no reaction from Euro and Sterling). This latter scenario is exactly what has been unfolding over the past several days, with market uncertainty running high and investors content on repatriating back into safer and lower yielding assets. Thursday’s disastrous Philly Fed only helps to reinforce this fact, with equities selling off sharply as a result, and the Dollar benefiting in the end against many of the other major currencies.

In reality, we don’t refer to the other major currencies in the classical sense, with only Sterling and the Euro negatively impacted by the damaged sentiment. Instead we refer to the more active currencies which include the commodity bloc and major emerging market FX. The only other currencies to outperform the USD have been low yielding and safe haven alternatives in the Yen and Swissie. We think it is important to differentiate between low yielding and safe haven as the relative strength in the Yen in our opinion is much more a function of its lower yield rather than any safe haven appeal. Swissie on the other hand continues to retain a safe-haven status, with the Franc shining in Thursday trade after rallying to fresh multi-week highs against the buck.

The Yen strength on the other hand is more questionable. Carry trade liquidation is seemingly far behind us (Yen crosses are all well off of their multi-year peaks) and the thought of investors finding comfort in the Japanese economy on a safe-haven appeal is improbable. We see the Japanese economy in serious trouble right now with the higher Yen now starting to really strangle growth prospects. There has been a major escalation in official talk on the topic of the currency, and it seems as though some form of official intervention can not be ruled out over the near-term. With that said, we still would not rule out the possibility for one more drop off in Usd/Jpy down towards and potentially below 84.00 before seeing what we expect to be a massive Yen capitulation.

Overall we continue to focus on the major weekly reversals seen in the previous week that favor an eventual resumption of USD buying against most of the major currencies. The broader instability in the global macro outlook lends support to this view and we would be looking to fade any additional USD weakness into Friday trade.

Looking ahead the economic calendar is anemic in Friday trade, with the only key data release coming out of Canada in the form of CPI (0.6% expected) at 11:00GMT. It is worth noting that the Australian Dollar could see some added volatility over the coming sessions, with the upcoming national election factoring into trade. Right now it is a very tight race, and the added uncertainty could result in some whipsaw trade.

GRAPHIC REWIND

TECHS

EUR/USD:The latest bout of consolidation could finally be coming to an end with the price action suggesting that the market wants to head lower. Look for a break and close below 1.2730 on Friday to confirm bias and accelerate declines towards the next key support which comes in by psychological barriers at 1.2500. The 50-Day SMA which has propped since early July coincides with the 16Aug lows at 1.2730, so a close below this level would be significant. Back above 1.2920 would negate and give reason for concern.

USD/JPY: Critical support by 84.80 has finally been broken to open some fresh multi-year lows by 84.70 thus far. Next key support comes in by 84.45, with a break below this level exposing the monthly lows from June 1995 further down at 83.50. However, as we have already warned, daily studies are starting to look stretched, and with 84.80 finally broken, any additional declines should be very well supported ahead of 83.50 in favor of a much needed upside reversal. A break and close back above 86.40 will be required at a minimum to relieve downside pressures.

GBP/USD:All eyes now on critical support by the 200-Day SMA which coincides with psychological barriers at 1.5500 right now. A close below this level will strengthen bearish structure and open a fresh downside extension towards next key support in the form of the 50-Day SMA at 1.5325, which guards against 1.5000 further down. Back above 1.5700 would give reason for concern.

USD/CHF:Has managed to break to yet another multi-week low on Thursday below 1.0300 to now potentially open a fresh downside extension towards the yearly lows from January by 1.0130 over the coming sessions. However, at this point, it is still too difficult to call, and with medium-term studies looking stretched, we would be more inclined to be looking for opportunities to buy rather than sell. The market still managed to close back above 1.0300 on Thursday and the recent multi-week range is more or less intact with the market just as easily seen bouncing sharply back towards 1.0600.

FLOWS

Asian central bank offers in Eur/Usd. Exporter selling of Usd/Jpy. Large stops below 0.6990 in Nzd/Usd. Buy-side shops selling commodity bloc. Macro names selling Eur/Gbp. Corporates buying Francs.

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Written by Joel Kruger, Technical Currency Strategist for DailyFX.com

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