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As USDOLLAR Presses Breakout Level, "Panic" Ensues in JPY-crosses

As USDOLLAR Presses Breakout Level, "Panic" Ensues in JPY-crosses

Christopher Vecchio, CFA, Senior Strategist

Talking Points:

- USD/JPY disconnected from rest of USD-complex.

- News cycle and global risk sentiment has turned markedly negative.

- See upcoming event risk for FX markets.

Risk sentiment is souring globally, and geopolitical tensions are feeding into the negative feedback loop. A third day of pressure in Asian equities arose after North Korea's nuclear test - a peculiar one at that, considering it's drawing the ire of its only trading partner, China - cementing the geopolitical news cycle in a state of "panic." The rapid sentiment swings are evident in retail trading crowd positioning as well.

For those inclined to view the world through a behavioral perspective, this latest episode of 'manias, panics, and crashes' is merely the symptom of a larger problem: the bubble created in asset classes across the globe thanks to loose monetary policy in the wake of the GFC. As economist Charles Kindleberger, author of "Manias, Panics, and Crashes," wrote, "new opportunities for profit are seized, and overdone." Now it seems that the latest bear wave of the news cycle is the straw breaking the camel's back, undoing Mr. Kindleberger's "overdone" mania condition.

If markets are engaged in the fearful "panic" stage - we've certainly not "crashed" yet - then it means we may be back in the "what's good data is bad news, and what's bad data is good news" mindset. In other words, economic data or events that would lead to an extension of loose policy from the BOJ and the ECB or a delayed hike cycle by the Fed would be perceived as "bullish" for risk assets. Consequently, it means competitive devaluations - as a way to insulate export figures during a global downturn - are increasingly likely. The ECB, for example, has made it quite clear that it finds a strong EUR/USD, in context of its technical assumption NEER, completely intolerable.

In this "panic" stage, heigtened volatility is all but guaranteed. It's a good time to stay on top of your risk management principles. Notably, now that more and more of the news cycle is focused outside of the prototypical peak liquidity hours of the day, the London-NY crossover, it may be especially prudent to reduce leverage and/or reduce overnight exposure.

As noted yesterday, should the FOMC meeting minutes today yield a determined, hawkish tone and concurrently the December US labor market report prove to be supportive of the US Dollar, it will likely come at the detriment of higher yielding currencies and risk-correlated assets.

In the "what's good data is bad news" world, any indication that the Fed could tighten policy faster than currently expected - only two rate hikes are priced in for this year (per Fed funds futures) - against rapidly deteriorating risk sentiment and an increasingly negative geopolitical news cycle would seem like a caustic mix of influences for the commodity currency bloc in particular, and continue to benefit currencies like the Japanese Yen and the US Dollar.

Read more: USDOLLAR Bull Flag Breakout Hinges on FOMC Minutes, NFPs

See the above video for technical considerations in the USDOLLAR Index, EUR/USD, AUD/USD, NZD/USD, GBP/JPY, AUD/JPY, and NZD/JPY. Also, read about my trade of the year: short GBP/JPY.

--- Written by Christopher Vecchio, Currency Strategist

To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com

Follow him on Twitter at @CVecchioFX

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

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