With the Federal Reserve removing the zero-interest rate policy (ZIRP) in 2015, the normalization cycle in the U.S. accompanied by the quantitative/qualitative easing (QQE) program in Japan may fuel a bullish outlook for USD/JPY amid the deviating paths for monetary policy.
The updated projections from the Federal Open Market Committee (FOMC) suggests the central bank will sound more hawkish in 2016 and take a standardized approach to implement higher borrowing-costs as the board pledges to further adjust policy in the months ahead. With the U.S. approaching ‘full-employment,’ data prints highlighting a stronger recovery may encourage the Fed to push through another rate hike in the first-half of 2016 but, the disinflationary environment across the major industrialized economies may become a growing concern for central bank officials amid the slowdown in global growth accompanied by the persistent weakness in commodity prices. Despite the unanimous vote to lift the benchmark interest rate in December, the external risks surrounding the region may spur a rift within the 2016 FOMC and generate headwinds for the greenback as Chair Janet Yellen appears to be in no rush to further normalize monetary policy.
At the same time, the Bank of Japan (BoJ) may continue to disregard market expectations for a larger asset-purchase program and largely retain a wait-and-see approach in the first-half of 2016 as Governor Haruhiko Kuroda remains confident in achieving the 2% inflation target over the policy horizon. Even though the BoJ fine-tunes its QQE program in December and keeps the door open to ramp up its non-standard measures, it seems as though the bar remains high for the central bank to embark on a more aggressive approach to expand its balance-sheet especially as the Japanese economy avoids a technical recession. In turn, more of the same from the BoJ in 2016 may undermine the bullish outlook for USD/JPY and heighten the appeal of the Japanese Yen as market participants scale back bets for a larger asset-purchase program.
Nevertheless, the current course for monetary policy in the U.S. and Japan may produce a further advance in USD/JPY over the coming months, and the pair may continue to retrace the decline from back in 2002 as the Fed gears up to remove the emergency measures throughout the year ahead. However, a more delayed normalization cycle in the U.S. paired with a material shift in the BoJ’s stance may produce range-bound conditions during the first three-months of 2016 as market participants gauge the prospects for future policy.
Japanese Yen’s ‘Funding Currency’ Status Raises Risk for Larger USD/JPY Correction
The Japanese Yen’s ‘funding-currency’ status may continue to play a key role in dictating price ahead of the key interest rate decisions as USD/JPY broadly moves in tandem with the global benchmark equity indices.
USD/JPY & S&P500
Data source: Bloomberg. Chart Prepared by David Song
Indeed, efforts by the community of global central bankers to avert a further slowdown in the world economy may prop up market sentiment, but fear of a ‘hard-landing’ in China paired with the weakened outlook for Emerging Markets may continue to sap investor confidence and spark a further unwinding of the ‘carry trade.’ In turn, shifts in risk trends may largely accompany turns in USD/JPY as market participants weigh the outlook for monetary policy.
Technical Analysis: USD/JPY at Long-Term Juncture
USD/JPY is at an important long term juncture. First, let’s look at the long term Elliott wave picture. Chapter 7 of Sentiment in the Forex Market (published in 2008) reads.
“Wave 4 completed in late July 2007 in the form of a triangle (a-b-c-d-e). Expectations then are for a drop below the 1995 low at 81.12 to complete wave 5. Since triangles lead to terminal thrusts, the 5th wave low will give way to a rally that could reach the triangle extreme near 150.00. In summary, expect price to come under 81.12 before a multi-decade low is registered.”
The rally from the 2011 low counts as a completed 5 wave advance. The implication is that a corrective process (weakness to a broad sideways range that could last at least several years) unfolds before strength can resume towards 150. That corrective process may be underway now, especially considering that the top in 2015 registered near a long term trendline confluence (underside of line that extends off of the 1995 and 2005 lows and line that connects the 1990 and 1998 highs) and the 2007 high (end point for cycle wave 4). Also, important reversals have materialized in years that end in 5 and a top registered after the last 3 year rally (1994-1996).
Trading wise, price action since December 2014 would complete a head and shoulders top on a drop below 115.57 and yield a target zone of 105.30-106.50. The target zone would be ‘in line’ with Elliott wave guidelines that suggest a corrective process terminates near the former 4th wave of one less degree (that zone is 101.07-105.44).
In summary, long term technical observations reveal a potential inflection point in the USD/JPY exchange rate. Trading behavior in 2016 may look quite different from what traders have seen over the last 4 years.
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