What’s next for USDJPY following BoJ-related rumours?

Summary:

• Japanese yields soar at the start of the new week propelled by revelations that the BoJ could tweak its monetary policy
• Yen net shorts rose to the highest since March, the option market implies more pain for the USDJPY as well
• Technical analysis suggests the pair could head south even toward 108

The latest Friday’s afternoon abounded in two major topics. Firstly, the US President Donald Trump accused foreign central banks (singling out the EU and China) of manipulating currencies as well as interest rates. His tweet saw an immediate decline in the greenback, equities felt the pain too. One may suppose that having Donald Trump upholding the US dollar ’fair’ (in his eyes) exchange rate scope for upside could be limited. Having this in mind the news concerning the Japanese central bank may seem even more important.

On Friday revelations that the BoJ could tweak its monetary policy hit the wires citing unnamed sources reporting to Reuters. Among possible changes to the current course are adjustments to interest-rate targets, stock-buying techniques and ways aimed at making the massive stimulus programme more sustainable. The report together with Trump’s remarks saw the USDJPY slumping and this move is continuing at the beginning of the new week as we have already mentioned in our first post. There is a simple question everybody wants to know an answer: does the USDJPY have more space to head lower on the back of the most recent developments?

1-month risk reversal for the USDJPY has plunged of late suggesting increased interest of hedging against the stronger yen. Source: Bloomberg

As a result of the Friday’s events the yield on the Japanese 10Y bond shot up closing 5 basis points higher and reaching 0.086% on Monday. The bearish start of trading on the national bond market prompted the BoJ to offer to buy unlimited JGBs with a 5-10Y maturity trying to put a ceiling on the yield. Even as this move could stop yields from rising it does not mean the JPY will stop rising as well. Looking at the chart above one may identify that option traders have increased their involvement in a trade giving a hedge against the stronger yen suggesting that they expect more gains ahead. However, betting on an end of the current ultra-loose monetary policy in Japan does not seem to be reasonable given still dormant domestic-driven inflationary pressures. Therefore, even as the JPY could keep on climbing over the next days this move is unlikely to be driven by expectations pertaining to the more hawkish stance of the BoJ. Notice that despite those revelations the likelihood for a rate hike (10 basis points) in Japan till the end of the year stands below 19%.

Positioning on the JPY has become yet more bearish based on the newest CFTC data. Source: Bloomberg, XTB Research

The option market is not the only one indication as for possible further gains on the yen, the CFTC latest report may also enhance these conjectures. According the the report the net short position on the yen increased to the highest since March (it presents closed positions as of 17 July) implying that there could be some space to unwind shorts. Before we move to technical analysis let us explain our justification behind limited expectations as for any more notable hawkish change to Japanese monetary policy. We reckon that these kind of expectations (based on remarks similar to those we knew on Friday) are steered more by other central banks signalling impending changes to their loose policies rather than on country’s inflation data. Anyway, bear in mind that from the long-term standpoint the JPY remains well below its fair value based on calculations of the real effective exchange rate. The next Bank of Japan meeting will take place next week, but do not expect any explicit signals that the bank will alter its policy meaningfully any time soon.

Looking at the weekly time frame of the USDJPY one may notice that the pair has already come back to its crucial support placed at 111. Therefore, intuition could suggest that expectations as for an increase are not baseless. Nevertheless, taking into account the all mentioned above one may become much less certain. Should the pair break through its trend line it could embark on a pullback even toward 108 where the major support may be found. Source: xStation5