Yen, EUR/USD Sag as the U.S. Dollar Drives Toward Three-Month Highs

2017-10-23 13:00:00

Talking Points:

- This week brings two important Central Bank rate decisions, with ECB on Thursday likely garnering considerable attention around-the-world. We discussed the upcoming BoC rate decision in this week’s fundamental forecast and below, we look into the upcoming ECB meeting.

- The big question is whether or not the ECB is ready to begin moving away from stimulus. EUR/USD has been soft since latter-September, and this is while the U.S. Dollar marches towards a key zone of resistance.

- Want to see how Euro and USD are holding up to the DailyFX Forecasts? Click here for full access.

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This week brings a pair of highly-important Central Bank rate decisions, and the weekend brought another dose of political-fed volatility. In Japan, PM Shinzo Abe enjoyed a rousing victory as his Liberal Democratic Party and its coalition partner took more than 2/3rds of the vote, affording Mr. Abe a strong new mandate. This should allow him to drive for the first changes to Japan’s pacifist constitution since it was introduced in 1947 after World War II.

While a similar gambit in the U.K. blew up with dire consequences, Mr. Abe called for early general elections in an effort to use a surge in poll numbers to take advantage of a weakened opposition party. Worries populated when shortly after the announcement of those early general elections, popular Tokyo governor Yuriko Koike announced that she was creating a new party, ‘The Party of Hope.’ But after this weekend’s decisive win for Mr. Abe and the LDP, those concerns of a weaker base for Mr. Abe have begun to dissipate. The immediate response upon market open was a jump-higher in the Nikkei along with another run of weakness in the Japanese Yen. In USD/JPY, the pair is now testing an area of resistance that’s held the highs in the pair for a large portion of the year.

USD/JPY Daily: Gap-Up to Resistance, Testing Seven-Month Highs

Chart prepared by James Stanley

With a strong dose of political risk now out of the way, and with Japanese voters having given Mr. Abe and the LDP another vote of confidence – we could see Yen weakness continue under the presumption that the BoJ will continue with their uber-dovish stance until inflation starts to show at a stronger rate. In August, we saw this number come-in at .7%, and this was after four consecutive months at .4%. We’re still quite a ways away from the 2% BoJ target, and that continued lag is what opens the backdrop for further easing from the BoJ.

Thursday brings September inflation for Japan. The expectation is for a flat print at .7%, just as we saw in August. Weaker reads will likely bring on Yen-weakness while stronger prints will probably bring a dash of strength. The big question, in that scenario, is for how long that strength might last and when Yen bears might come back to push the trend-lower?

At this stage, we’re at range resistance. This is where bulls will want to be cautious, as this area of resistance has twice rebuked USD/JPY’s upward advance. In each instance of this prior resistance, a sell-off of more than 500 pips showed-up shortly thereafter. A topside break of range resistance, particularly with our current backdrop could make for an interesting setup on the bullish continuation side of the trade, with forward-looking targets cast towards prior areas of resistance around 115.50, 116.75 and then the double-top formation towards 118.67.

USD/JPY Four-Hour: Testing Resistance Zone, Seven-Month Highs

Chart prepared by James Stanley

Thursday is ECB Day

The big item on the calendar for this week is a European Central Bank rate decision set for Thursday, and for the first time in almost a year, markets are actually expecting to hear something, in some fashion by way of new information.

For much of the year the ECB has been evasive on the topic of stimulus exit. This hasn’t stopped markets from factoring in the prospect of higher rates under the presumption that the ECB will inevitably make a move towards ‘less loose’ monetary policy. The current stimulus program is set to expire in December; and Thursday brings the last ECB meeting before the December rate decision.

The prevailing thought, and this was brought upon by comments from the ECB’s Chief Economist towards the end of September, is that we’ll see the bank ‘recalibrate’ their current program while extending the duration. The popular expectation appears to be currently hovering at around ~€30 Billion per month. Since those comments came out from Mr. Praet at the end of September, the bullish trend in EUR/USD has come under pressure. The pair remains supported at a huge zone of longer-term support that we’ve been following that runs from 1.1685-1.1736.

Chart prepared by James Stanley

This pullback from the highs marks an approximate 23.6% retracement of the 2017 bullish trend in the pair; but more troubling for bulls should be the constant effort from sellers as prices have bounced from support. The lower-highs that have continued to print on the below chart should be an unwelcome sign for bulls, and if we do see a downside test of the prior higher-lows set earlier in October, we could be looking at a bigger retracement of that longer-term trend, with an eventual re-test of the 1.1500 psychological level.

EUR/USD Four-Hour: Long-Term Support Holding, but Sellers Getting More Aggressive

Chart prepared by James Stanley

U.S. Dollar Drives Towards Resistance

Last week saw strength come back into the U.S. Dollar, and this was on the heels of a CPI report from the prior Friday that showed 2.2% inflation in the U.S. The Fed continues to talk up the prospect of a hike in December, and throughout October, we’ve seen bearish price action start to dissipate as bulls have continued to come-in to offer support at higher-lows.

U.S. Dollar via ‘DXY’ Four-Hour: Higher-Lows Since September Swoon

Chart prepared by James Stanley

At this stage, a re-test of the key resistance zone that runs from 94.08-94.30 appears highly likely. This area had helped to set a top earlier in October, and a re-approach towards this zone gives the appearance that buyers might finally be able to push price action up to fresh three-month highs.

U.S. Dollar via ‘DXY’ Daily: Fast-Approaching Long-Term Resistance Zone, Three-Month Highs

Chart prepared by James Stanley

If we do see a top-side break of this resistance, the U.S. Dollar could have some room to run after the -12.3% drawdown that showed-up in the first nine months of the year. On the chart below, we’re looking at prior points of support that become interesting as new targets for resistance should this bullish theme continue to develop.

U.S. Dollar via ‘DXY’ Four-Hour: Potential Resistance Should Deeper Move of USD-Strength Show