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The Answer to That Burning USD/JPY Question

The Answer to That Burning USD/JPY Question

Kathy Lien, Technical Strategist

A sudden panic has struck the forex market, kicking off a massive wave of USDJPY selling that could continue all the way down past 100 en route to the 98.50 support level.

The biggest mover in the FX markets today is the Japanese yen (JPY). The 7% decline in the Nikkei overnight kicked off a wave of deleveraging in the financial markets as investors around the world hit the panic button.

What is interesting about the move is that no one is buying the US dollar (USD), a currency that generally performs well during periods of risk aversion. The reason for this is because to de-lever means to reduce positioning, and over the past month, investors had been gradually increasing exposure to US dollars. As a result, they are cutting that exposure today.

See also: Stunning Reversals Shock the FX World

The move in the dollar has nothing to do with US fundamentals, as jobless claims dropped more than expected and house prices increased 1.3%. After rising to 363K the prior week, jobless claims fell to 340K, a number that is consistent with a continued recovery in the US labor market. These improvements keep the Federal Reserve on track to taper asset purchases later this year.

However, the burning question on everyone's minds is not about the dollar, but about the yen: Has the yen finally hit a bottom, and is the USDJPY rally over?

First and foremost, it is important to understand what triggered the selloff in USDJPY. The 10-basis-point (bp) surge in ten-year US Treasury yields yesterday caused a gap higher in Japanese government bond (JGB) yields, which in turn triggered the collective selloff in the Nikkei and USDJPY. Weaker Chinese manufacturing PMI numbers added salt to the wound by exacerbating risk aversion and the slide in USDJPY.

Previously, we said there are three criteria for a continued rally in USDJPY: 1) Rising US bond yields; 2) New highs in the Nikkei; and 3) Increased Japanese purchases of foreign bonds. US bond yields increased sharply on Wednesday, and while Fed policy should keep yields in an overall uptrend, they are lower today. The Nikkei has collapsed, and according to the Ministry of Finance's weekly portfolio flows report, Japanese investors were net sellers of foreign bonds last week, and the amount they sold completely undoes the buying over the past three weeks.

As a result, this reversal in USDJPY is not just technically driven. It has fundamental support and could extend down to 100 and possibly even 98.50. However, we believe that losses will be contained to this level due to the divergence between US and Japanese monetary policies. The recent increase in JGB yields will only give the Bank of Japan (BoJ) greater conviction to ease, whereas the recent uptick in US yields will eventually attract Japanese interest.

By Kathy Lien of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.