Speculators are quick to buy the dips in the USD/JPY pair at the slightest opportunity. It makes little difference what triggers the decline—whether it’s currency intervention or a weaker US dollar following disappointing employment data. Let’s take a closer look at the factors driving the pair and develop a trading plan.
The article covers the following subjects:
Major Takeaways
- Automakers’ hedging activity will weigh on the yen.
- The carry trade continues to favor the USD/JPY.
- Japanese households remain cautious.
- Pullbacks present an opportunity to add to long positions opened on the USD/JPY above 156.
Weekly Fundamental Forecast for Yen
An unexpected decline in US employment triggered a massive sell-off in the US dollar. USD/JPY bears seized the opportunity, pushing the pair to its lowest level since the last coordinated intervention. However, speculators quickly bought the dip, once again following the classic “buy low, sell high” strategy. Against this backdrop, the Japanese yen appears particularly vulnerable.
Speculative Positions on Yen
Source: Bloomberg.
The joint intervention by Tokyo and Washington in the Forex market has significantly thinned the ranks of speculators, but it has done little to curb their appetite for the USD/JPY. Hedge funds’ net short positions in the yen have fallen by half from their 2007 peak. The market has shed much of its excess positioning, and the US dollar has begun to rise again.
There are plenty of reasons to buy the USD/JPY. It’s not just the wide interest-rate differential, which supports demand for carry trades and encourages large-scale selling of the yen as a funding currency. Japanese automakers expect the US dollar to trade in the ¥157–160 range over the next 12 months. If the price falls below that range, they are likely to step in and hedge their exposure by buying the pair. This suggests there is a clear support level. The question is: where is the ceiling?
The authorities’ divergent policies—with the Bank of Japan pursuing monetary tightening while the government favors fiscal stimulus—are prompting consumers to remain cautious. Despite rising real wages, household spending unexpectedly declined in June, marking its seventh consecutive monthly drop and highlighting consumers’ reluctance to spend. Most likely, households are channeling more of their income into savings, and the higher the overnight rate rises, the stronger this tendency is likely to become. As a result, economic growth could slow further, while the yen may remain under pressure.
Japan’s Household Spending
Source: Bloomberg.
According to Morgan Stanley, unless the US and Japan launch another coordinated intervention, USD/JPY quotes are likely to continue moving gradually but steadily higher.
The Bank of Japan still has the power to curb the rally. However, the minutes of its latest Governing Board meeting showed that only one of the nine members was prepared to vote for tighter monetary policy. According to this lone hawk, with inflation approaching the 2% target, the pace of monetary tightening should be faster than markets currently anticipate. At present, derivatives are pricing in a 60% probability of an overnight rate hike by September.
There is also a risk that Tokyo could intervene in the foreign exchange market once again during the Obon holiday on Tuesday, when Japanese markets will be closed. Thin liquidity during the holiday could amplify yen volatility.
Weekly USDJPY Trading Plan
In any case, the previously mentioned strategy of buying the USD/JPY on pullbacks toward 156 continues to work.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of USDJPY in real time mode
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