A couple of months ago, I wrote this, which, though I say so myself, worked out pretty well. In the article, I predicted that USD/JPY would approach 100, falter a little, and then break through the level before topping out at about 103-104 and returning below 100. So far, so good….
The problem with making detailed prognostications such as that is that if you get it wrong, you’re a bum. If you get it right, people demand that you keep making predictions…. until you get it wrong, then you’re a bum. With that said, the fact remains that “Where next?” is an interesting question.
Forex is often seen by outsiders as a purely technical market, and on a day to day basis that is mostly true. In my nearly twenty years in the FX market, however, I found that virtually all interbank spot traders had a solid grasp of fundamentals and a long term view. They rarely acted on it and had no trouble trading against it intraday, but it was there in the background, and to some extent it colored their decision making. Times like these are when that long term view becomes important.
In the last couple of months, USD/JPY has become very volatile and, as a result, less liquid than usual. Technical levels and indicators are becoming increasingly irrelevant and the market has demanded to be traded by the seat of your pants rather than by technical analysis. When this happens only two things matter, the fundamentals of the currency pair and the positioning of traders. These are the factors that must be considered going forward.
The power of the positioning of the Forex market is something that paid traders understand all too well, but it can be confusing for individual, retail traders. Take the move off of the highs in the last couple of weeks in USD/JPY. The fall started when Ben Bernanke hinted at the “tapering” of QE in the US. Think about that for a minute. Talk was of slowing, and eventually exiting a policy that increased the supply, and therefore decreased the relative value, of the US Dollar. Japan, meanwhile, remained as committed to “Abenomics” and a weaker Yen as ever. The US Dollar was set to strengthen and the Yen to weaken further. USD/JPY should have continued on upwards, surely? Ah, but not so fast, Mr. Bond!
At that point, anybody who wanted to be long USD/JPY already was long, and, chances are, given the size of the move up, they were getting a little nervous. Hedge funds, large banks’ strategic desks and other institutions had begun buying at the end of 2012, when USD/JPY was in the 80’s and were always looking to take a profit above 100. Thus, when Bernanke spoke, the market interpreted it as “If the US ends QE, then Japan will too and the great Yen short will be over… sell now before it’s too late!” In the light of this (which I’ll admit is speculation, albeit informed) the seemingly illogical move down makes sense.
The drop back below 100, then, begins to look like a normal correction in an overbought market. So, any opinion as to what happens next should be based on the fundamental strength or weakness of the currencies. When all is said and done, little has changed.
Both the US and Japan are, in effect, printing $85 Billion of their respective currencies each month. The relative effect of this on the Yen is greater as their economy is smaller, and an end to QE is in sight here in the US. Both nations’ sovereign bonds have dropped in value over the last few weeks, causing yields to rise, but the 10YR JGB still yields less that 1% compared to over 2% for the US 10YR. In short, everything still points to USD/JPY moving higher again.
It could be that the correction is not yet over, so small positions with distant stops would be the order of the day. It seems to me only logical that USD/JPY will soon resume its upward trend and break through 104.00. Should I be wrong, feel free to call me a bum.