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The USDJPY Breakout is the Real Deal, but What’s the Major Risk?

The USDJPY Breakout is the Real Deal, but What’s the Major Risk?

2013-09-03 14:45:00
David Rodriguez, Head of Product
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- USDJPY has broken above major price resistance

- We think the price breakout along with our forex positioning data favors strength

- Key risk is sharp equity market turn lower

We have been calling for US Dollar strength against the Euro and other forex counterparts for a number of weeks now, and indeed we believe that this is the start of a large USDJPY breakout. Why do we believe so and—just as importantly—what could derail the USDJPY surge?

USDJPY Breaks Above Key Resistance, Favors Further Gains

forex_sentiment_warns_of_USDJPY_break_higher_body_Picture_5.png, The USDJPY Breakout is the Real Deal, but What’s the Major Risk?

Source: FXCM Trading Station Desktop, Prepared by David Rodriguez

One major reason for Japanese Yen weakness versus its US counterpart has been strength in the Japanese Nikkei 225; the correlation chart below emphasizes the strength of said correlation since the USDJPY set a major low in 2012.

Japanese Yen Weakness May Continue as the Nikkei 225 Surges

forex_sentiment_warns_of_USDJPY_break_higher_body_Picture_6.png, The USDJPY Breakout is the Real Deal, but What’s the Major Risk?

Data source: Bloomberg

Of course, this correlation is a double-edged sword; a turn lower in global equity markets could just as easily derail the USDJPY break higher.

In fact we saw a preview of said risk overnight as both the Nikkei and USDJPY tumbled on news of a potential airstrike in the Middle East.

Overnight Stock Market Tumble Underlines Risks to USDJPY Long Trade

forex_sentiment_warns_of_USDJPY_break_higher_body_Picture_7.png, The USDJPY Breakout is the Real Deal, but What’s the Major Risk?

Source: FXCM Trading Station Desktop, Prepared by David Rodriguez

We’ll have to keep an especially close eye on equities going forward, as it’s clear that sharp moves could derail the nascent USDJPY breakout. Yet our proprietary forex crowd sentiment data helps confirm that this may in fact be the start of a larger US Dollar breakout.

Major Shift in Forex Sentiment Suggests USDJPY Breakout is the Real Deal

forex_sentiment_warns_of_USDJPY_break_higher_body_Picture_8.png, The USDJPY Breakout is the Real Deal, but What’s the Major Risk?

Source: FXCM Execution Desk Data

We typically use our Speculative Sentiment Index data as a contrarian indicator to price action. Or in plain English: when everyone’s buying, we look to sell.

Recently our SSI data showed crowds at their most net-long USDJPY since the start of its impressive reversal in September of last year. That might normally make us bearish as price is likely in a downtrend, but impressively one-sided sentiment likewise warns of a potential turn.

Retail forex long positions in the USDJPY have fallen by a substantial 40 percent from their recent peak, and that has led our sentiment-based Momentum2 trading system to go in the opposite direction.

We like those positions as long as stocks continue to hold gains, and it will be critical to watch the Nikkei’s next moves going forward.

Receive future special reports on the USDJPY, forex positioning, and correlations via my e-mail distribution list with this link.

Forex Correlations Summary

View forex correlations to the S&P 500, S&P Volatility Index (VIX), Crude Oil Futures prices, US 2-Year Treasury Yields, and Spot Gold prices.

forex_sentiment_warns_of_USDJPY_break_higher_body_Correlations0.png, The USDJPY Breakout is the Real Deal, but What’s the Major Risk?

Data source: Bloomberg. Chart source: R

SEE GUIDE ON READING THE ABOVE CHART

--- Written by David Rodriguez, Quantitative Strategist for DailyFX.com

David specializes in automated trading strategies. Find out more about our automated sentiment-based strategies on DailyFX PLUS.

Contact and follow David via Twitter: https://twitter.com/DRodriguezFX

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

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