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The Home Run Trade That's Striking Out Now

The Home Run Trade That's Striking Out Now

Kathy Lien, Technical Strategist

Having quietly put in a fresh monthly low today, the long USDJPY trade, which seemed like a runaway winner that would last all year in the early part of 2013, has potentially come into question.

The FX market may be captivated by the big moves in the British pound (GBP) today, but USDJPY has quietly dropped below 97 to put in a fresh one-month low. The idea of buying USDJPY—once touted as one of the best trade opportunities of 2013—is now looking tenuous.

With no US data on the economic calendar today, the latest selloff in USDJPY, which marks the fourth consecutive day of weakness for the pair, has been driven by the 4% overnight decline in the Nikkei and the drop in US ten-year yields.

Concerns about Fed tapering, the recent strength of the Japanese yen (JPY), and uncertainty surrounding the upcoming Bank of Japan (BoJ) meeting have all contributed to the weakness in Japanese stocks, and USDJPY has a negative correlation with the index.

The BoJ began its two-day meeting today, and though no policy changes are expected, an official announcement will be made on Thursday.

Meanwhile, the break of the prior monthly low puts USDJPY at risk of slipping down to its June lows near 95.

An All-Time First for the Bank of England (BoE)

In the UK, the Bank of England (BoE) quarterly inflation report triggered a significant amount of volatility in the British pound. The central bank has now adopted a 7% unemployment rate threshold, which means that interest rates will not be raised as long as unemployment remains above 7%.

See related: GBP Rallies on Historic BoE Announcement

The UK jobless rate currently stands at 7.8%, and according to the latest BoE forecasts, the unemployment rate will remain above the new threshold until "at least 3Q of 2016." This puts the first potential rate hike much later than the market first anticipated, and for this reason, the initial reaction was in favor of GBP weakness.

At the same time, however, the BoE also upgraded its 2013 GDP forecast to 1.5% vs. 1.2% in May, and more significantly, upgraded the 2014 GDP forecast to 2.7% from 1.9%. In other words, the central bank expects easy monetary policy to fuel significantly stronger growth next year.

If the central bank's growth forecast is on target and the momentum is sustained into 2015, we would not be surprised if the unemployment rate falls faster than the central bank currently anticipates. However, the Bank’s prediction that the 7% mark will not reached until late 2016 is an attempt to convey an ultra-dovish monetary-policy stance to the market.

While sterling has since soared, the combination of dovish forward guidance and a higher GDP forecast means potential for more extended range trading in the GBPUSD. Gains should be capped at the June highs of 1.5750, and losses should be limited to the July lows at 1.48. This may be a wide range, but there has been significant GBPUSD volatility in recent weeks.

Canada’s Economy Takes a Surprising Hit

Finally, the Canadian dollar (CAD) extended its losses after the IVEY PMI index printed at its weakest level in eight months. Not only was this the first contraction in manufacturing activity since November 2012, but the index also fell far short of expectations.

Economists had been looking for the IVEY PMI index to rise to 57 from 55.3, but it instead dropped to 48.4. Combined with the 10.3% drop in building permits, the outlook for Canada's economy has now worsened, putting USDCAD at risk of hitting 1.05 in the near term.

By Kathy Lien of BK Asset Management

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