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The USD/JPY Question Everyone's Asking

The USD/JPY Question Everyone's Asking

Kathy Lien, Technical Strategist

The Bank of Japan’s decision to withhold additional stimulus has set off a sharp yen rally, and now, with no intervention upcoming, traders are left to wonder how much further the USDJPY pair will fall?

Currencies were front and center on Tuesday courtesy of the big moves in the Japanese yen (JPY). We have not seen a decline as deep as the one in USDJPY since repatriation drove the yen sharply higher after the March 2011 earthquake and tsunami.

Those trading currencies at the time may remember that shortly after, USDJPY dropped more than 4% in one day and the G7 responded with coordinated intervention to weaken the yen.

Unfortunately, traders can't expect the G7 to step in this time around to halt the rise in the yen because the only reason they agreed to do so in 2011 was to provide global support to Japan after the earthquake and tsunami.

This time, the Bank of Japan (BoJ) caused the yen to rise by denying additional stimulus. In the past 24 hours, the USDJPY fell 3% and is now close to 7% off its May high. With no G7 support likely, traders are left to wonder how much further USDJPY will slide?

See also: A Local Decision with Global FX Implications

From a technical perspective, the downward momentum in USDJPY is very strong with 95 being the key support level for the pair. This level continues to hold for the time being, but if it is broken, there is very little support until 0.9150, which is the 38.2% Fibonacci retracement of the 2008-to-2011 rally that took the pair from a low of 60 cents to a high above 1.10.

Currently, there's very little reason to pick a bottom in any of the yen pairs, and for those banking on the 95 level to hold, stops are absolutely necessary, and even then, positions could be subject to significant slippage by brokers if 95 gives way and the pair falls sharply.

From a fundamental perspective, the currency could continue to rise, driving USDJPY to fresh lows.

Having just made a monetary policy decision to do nothing, we are skeptical about the chances of a U-turn by Japanese officials, but the markets have been extremely volatile, and BoJ Governor Haruhiko Kuroda may soon learn the dire consequences of overconfidence.

The Primary Driver of US Dollar Flows

The lack of US data early this week has not translated into a lack of volatility for the US dollar (USD) or the FX market in general. The dollar traded lower against all major currencies with the exception of the Australian dollar (AUD) and New Zealand dollar (NZD). Even against the commodity currencies, the dollar is well off its highs.

US markets were extremely volatile with stocks oscillating in and out of positive territory. US 10-year bond yields also rose to a one-year high of 2.29% before settling down a few basis points. With no US data on the economic calendar, the volatility was caused entirely by risk aversion. In fact, Tuesday was perfect example of how the actions of the Japanese can have global ramifications.

We have long warned that the steep losses in the Nikkei point to a potential correction in US stocks, and while the selloff in the S&P 500 was still modest, US markets may have a very tough time recapturing their losses if the Nikkei fails to recover.

For investors, the recent decisions in Japan could continue to have global ramifications. With no US economic reports scheduled for release on Wednesday, the dollar will continue to take its cue from the market's appetite for yen.

Euro (EUR) Hits Fresh Three-Month Highs

The euro (EUR) hit a fresh three-month high against the US dollar despite dovish comments from European Central Bank (ECB) officials. According to Jorg Asmussen, the central bank is prepared to purchase unlimited government bonds via outright monetary transactions (OMTs) and will sell bonds purchased once the monetary transmission mechanism is unblocked. While there is no immediate need to activate OMTs, the mere discussion of it suggests that European policymakers maintain a dovish bias.

ECB member Peter Praet also felt that inflation today is "on the low side," which gives the central bank the flexibility to keep monetary policy easy.

There were no major Eurozone economic reports released, but the German Constitutional Court began its hearing on the legality of OMT. The ECB has the support of the German Finance Minister, who argued that the Court had no jurisdiction over the program and credited OMT for saving the Eurozone from a messy sovereign debt crisis.

Unfortunately, the head of the Bundesbank feels that OMT threatens Germany's ability to manage its own monetary policy. While there are both strong supporters and critics of OMT, we feel that in the end, the benefits of making OMT available have been clear, and to reject its legality would mean re-introducing a fresh source of uncertainty for the financial markets.

German and French consumer prices are scheduled for release on Wednesday, and for the most part, these reports are expected to show that inflationary pressures remain low across the region.

Meanwhile, the Swiss franc (CHF) soared against the euro and US dollar after the State Secretariat for Economics upgraded the country's 2013 GDP forecast to 1.4% from 1.3%. Consumer prices are also expected to drop 0.1% this year compared to a prior forecast of 0.1% growth.

RBNZ Rate Decision Upcoming

The AUD was destroyed in early-Tuesday trade, and while the AUD and NZD extended their losses against the USD today, both currencies ended the North American trading session well off their lows. In fact, some technicians may even argue that the long wicks in AUDUSD and NZDUSD point to a potential reversal, or in this case, a stronger recovery for both pairs.

Given how grossly oversold these pairs are, we wouldn't be surprised if there is a relief rally, but there's no specific catalyst expected over the next 24 hours.

The Reserve Bank of New Zealand (RBNZ) rate decision is due out Wednesday afternoon in NY (Thursday morning in New Zealand). The RBNZ is not expected to change interest rates, but comments about the New Zealand dollar could have a significant impact on the currency.

When we last heard from the central bank, the RBNZ expressed their concerns about the NZD, which had risen to a four-year high against the AUD. There's been very little relief since then, and there is a very good chance the RBNZ will harden their warning about intervention, which could extend the slide in the NZDUSD and finally stop AUDNZD from falling.

UK Jobs Report Due on Wednesday

The British pound (GBP) continued to rise against the US dollar and euro after UK industrial production rose by 0.1%. The report released by the Office for National Statistics revealed that industrial production gained 0.8% in the past three months, which was the largest increase since July 2010.

With the Bank of England (BoE) holding off on any further easing earlier this month due to signs of recovery in the economy and the British Chamber of Commerce raising its growth forecast last month, the outlook for the UK is bright.

Labor market numbers will be released on Wednesday, and we believe jobless claims will continue to fall. Last month, the service sector saw its strongest growth in three months while the manufacturing sector enjoyed its first month of job growth in four. Good data from the UK would likely compound the gains in the GBPUSD and other GBP-based pairs.

By Kathy Lien of BK Asset Management

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

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