USDJPY Outlook Holds Bearish Course Despite Dollar and Risk Trend Conflict

USDJPY, Dollar, Risk Trends and Carry Trade Talking Points:

• The Market Perspective: USDJPY Bearish Below 132
• In a volatile first ‘full’ season of the new year, USDJPY plumbed lows not seen in six months with a tentative picture of what looks bigger picture like a V-top from October
• There are two themes USDJPY watchers should keep particular focus on: carry trade potential and risk appetite trends which don’t always line up for this pair

The start of the new trading year proved volatile yet uncommitted for much of the global market. The return of liquidity after the extended holiday period takes time, but the markets tend to refill in waves. This first tide generated a significant amount of volatility, but the absence of a clear fundamental thread for the financial system would make it difficult to offer true progress. For USDJPY, two principal forces of risk appetite and interest rate projections didn’t seem to generate the expected traction we would expect on a fundamental basis.

While both currencies in the USDJPY pairing are considered to be ‘safe havens’ in their own right, nuance tends to ramp up when they are combined. Under ‘normal’ circumstances, the Japanese Yen tends to gain in a ‘risk off’ environment not because American capital (or foreign capital held in the US) flees to Japan for greater safety. More practical is that carry trade that originated in Japan at lower yields and was invested in the US for higher return is unwound. The caveat is at the extremes. When liquidity is of principal importance, there is no question as to which currency will act the beacon. Though Fed forecasts have been a key talking point in 2022 and will be so again this year, there hasn’t been a catalyst to reconstitute traction. Meanwhile, the first day of trade for risk assets was only modestly lower (below the risk-based S&P 500 is inverted) which would cater to a mild carry pressure. In essence, these are offsetting forces but the lack of conviction on either leg helps to bolster the strength behind the speculative groups abiding by technicals.

Chart of USDJPY Overlaid with DXY Index and Inverted S&P 500 with 20-Day Correlations (Daily)

Chart Created on Tradingview Platform

Taking out the fundamentally-oriented visuals, USDJPY’s technical picture looks remarkably productive over the medium-term. While today’s session has not offered up significant progress, the general trend these past two months has projected far for the bearish crowd. From the intraday high on October 21st, USDJPY has dropped approximately -14 percent. Overall the 50-day rate of decline is the fastest we have seen since the height of the fear during the 2008 Great Financial Crisis. The lack of conviction from the pair through the current session alone is leaving us with large ‘wicks’ which denotes indecision. That said, this lack of conviction hasn’t prevented the pair from progressing through the previous support confluence zone of 131.50-00.

Chart of USDJPY with 20-Day SMA and ‘Wicks’ (Daily)

Chart Created on Tradingview Platform

Turning to a higher time frame, technical weight becomes a little more pronounced. From the initial head-and-shoulders break at 145 on November 10th, we have seen this pair take significant steps to break through support levels that were developed through periods of congestion that formed through the previous year. More than just the level that traded resistance in May for support for the second half of 2022, the 131.50 area was also the 38.2 percent Fibonacci retracement of the 2016 low to October 2022 high. So, whether you are looking at the technicals on a shorter term chart or the largest, progress is seen as significant. That said, speculative interest is still attempting to project a bullish outlook. This is both true of futures markets in the COT report as well as the retail side via the IGCS. To some, that suggests there is still a portion of the market that holds out for a charge, but it also means there is a group that has yet to capitulate and could be forced to feed bearish fires.

Chart of USDJPY with 200-Day SMA and COT Net Spec Futures Positioning (Weekly)

Chart Created on Tradingview Platform

Though we are very early in the new month (much less year), it is worth taking a glance at the monthly picture of USDJPY as well. The scale of technical support levels that we have passed and that are still ahead become clearer. Also, the incredible pace of the back-to-back losses between November and December is also on clear display. If the fundamental pressures of carry unwind and risk aversion let up, it could eventually open up the perception that this pair has dropped ‘too far, too fast’ – though fighting prevailing trends should only be done when you have the greatest confidence that it can actually gain traction. For me, that comes with fundamental and technical backing.

Chart of USDJPY with 100-Day SMA and 1-Month Rate of Change (Monthly)

Chart Created on Tradingview Platform