USDOLLAR Index Holding Support as USD/JPY Dives
- Weaker USDOLLAR relative to January insulating US equities.
- As market volatility rises, it's a good time to review risk management principles.
When you turn to a USDOLLAR Index daily chart, it seems like there's much ado about nothing: a doji candle forming after another failed run at support dating back to September 2015. Yet, as has been the case frequently during periods of high intensity in the market, the four components of the USDOLLAR Index often don't agree. Superficially, you end up with price action seen thus far today; below the surface, there's clearly something afoul in USD/JPY.
Reflecting on Japanese Yen price action thus far at the start of the new quarter, it seems as if the market is behaving in a way indicative of liquidity issues facing the Japanese government bond market. While we correctly predicted transmission issues in JGBs in December, the BOJ's negative rates policy (NIRP) wasn't yet seen as a realistic option (it arrived on January 29, 2016, eight days after BOJ Governor Kuroda said NIRP wasn't an option). NIRP may be the limiting factor in a VaR shock in JGBs to date, even though events that have transpired over the past few months - already one canceled auction (and a rumor of a second in the future)* and not a single trade being placed in the 30-year JGB last week - suggest that there are indeed liquidity issues in play.
Accordingly, whereas JGB yields may not be pricing in such an event, the Japanese Yen is behaving in such a manner - that liquidity issues are in play and that the BOJ's policies are failing. In mid-2003, when there was a VaR shock in JGBs that sent the 10-year JGB from ~0.400% to ~1.600%, the Japanese Yen trade-weighted index went on a +8% tear over the course of six months. This year? The Japanese Yen trade-weighted index is up by +6.2% through the first three-plus months of 2016.
If you haven't yet, read the Q2'16 Euro Forecast, "EUR/USD Stuck in No-Man’s Land Headed into Q2’16; Don’t Discount ’Brexit’," as well as the rest of all of DailyFX's Q2'16 quarterly forecasts.
*Edited for clarification; JGB auction two days ago went off as planned.
--- Written by Christopher Vecchio, Currency Strategist
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