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Japanese Yen Outperforms on Rising Trade Tension, Falling US Yields

Japanese Yen Outperforms on Rising Trade Tension, Falling US Yields

David Song,
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Japanese Yen Talking Points

USDJPY finally snaps the range-bound price action from the previous month, and the Japanese Yen may continue to benefit from the current environment as there appears to be a material change in risk-taking behavior.

Japanese Yen Outperforms on Rising Trade Tension, Falling US Yields

The Japanese Yen outperforms its major counterparts as President Donald Trump tweets that "the United States will impose a 5% tariff on all goods coming into our Country from Mexico," and the ongoing shift in trade policy may keep USDJPY under pressure especially as U.S.Treasury yields slip to fresh yearly lows.

It remains to be seen if the Federal Reserve will respond to the weakening outlook for global growth as the International Monetary Fund (IMF) insists that ‘consumers in the US and China are unequivocally the losers from trade tensions,’ and the central bank may start to alter the forward-guidance for monetary policy in an effort to insulate the economy.

Image of fed fund futures

Fed Fund futures now show a greater than 90% probability for a December rate-cut, and the Federal Open Market Committee (FOMC) may come under increased pressure to reestablish its easing cycle as the central bank plans to wind-down the $50B/month in quantitative tightening (QT) over the coming months.

However, the FOMC may find it difficult to abandon the rate hiking cycle as higher tariffs are seen feeding into consumer prices, and Chairman Jerome Powell & Co. may continue to project a longer run interest rate of 2.50% to 2.75% at the next quarterly interest rate decision on June 19 as "many participants viewed the recent dip in PCE inflation as likely to be transitory."

As a result, the FOMC may reiterate that ‘if the economy evolved as they expected, the Committee would likely need to firm the stance of monetary policy to sustain the economic expansion and keep inflation at levels consistent with the Committee's objective,’ and the lack of urgency to alter the forward-guidance may heighten the appeal of the U.S. Dollar as it curbs bets for an imminent Fed rate-cut.

Nevertheless, the recent pickup in USDJPY volatility appears to be shaking up market participation, with retail sentiment sitting at an extreme reading.

Image of IG client sentiment for usdjpy rate

The IG Client Sentiment Report shows 74.0% of traders are now net-long USDJPY compared to 66.5% last week, with the ratio of traders long to short at 2.85 to 1.In fact, traders have remained net-long since May 3 when USDJPY traded near 111.40 even though price has moved 2.8% lower since then.The number of traders net-long is 3.1% higher than yesterday and 4.4% higher from last week, while the number of traders net-short is 28.5% lower than yesterday and 25.7% lower from last week.

The drop in net-short position points to profit-taking behavior as USDJPY fails to retain the range-bound price action from the previous month, but the ongoing buildup in net-long interest offers a contrarian view to crowd sentiment especially as USDJPY fails to fill the gap from the previous month.

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USD/JPY Rate Daily Chart

Image of usdjpy daily chart
  • The USDJPY correction following the currency market flash-crash may continue to unravel as price and the RSI snap the bullish trends from earlier this year, with the break/close below the 108.30 (61.8% retracement) to 108.40 (100% expansion) zone raising the risk for a further decline in the exchange rate.
  • Next downside area of interest comes in around 106.70 (38.2% retracement) to 107.20 (61.8% retracement) followed by the 105.40 (50% retracement) region.
  • Recent developments in the RSI suggest the bearish momentum is gathering pace as the oscillator extends the downward trend from the previous month and pushes into oversold territory.

For more in-depth analysis, check out the Q2 2019 Forecast for the Japanese Yen

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--- Written by David Song, Currency Strategist

Follow me on Twitter at @DavidJSong.

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