The battle of the loosest central banks

With Mario Draghi prompting increased expectations of QE in the New Year from the ECB and the BoJ increasing the scale of its own QE program, it’s worth looking at EUR/JPY and the battle of the loosest central banks.

Source: Bloomberg

EUR/JPY rallied from ¥136.29 on 16 October to ¥149.14 on 20 November as the market got excited by moves from the BoJ to expand the amount of Japanese government bonds, REITS and ETF’s. Still, with the market increasingly believing the ECB will go all out to promote inflation expectations, will the Europeans cause EUR/JPY to retrace some of the gains?

My belief is they will. Admittedly, there have been some tentative signs of improvement in Europe with the ZEW investor survey improving, while overnight the IFO business confidence was modestly better than forecast. However, we must remember that inflation is key and on Friday we are likely to see the ‘flash’ print growing a meagre 0.3% year-on-year. Bundesbank president Olivier Weidmann detailed high hurdles for ECB government buying. To be fair, these won’t surprise many as he has had this stance for a while. Still, it really does highlight that if the ECB are going to buy government bonds, the Germans are going to protest.

On the other side of the scale, the Abe government in Japan have started talking up the JPY, with finance minister Taro Aso showing concern around the pace of JPY weakening last week. This should become more of an issue as we enter the 14 December Japanese election.  A survey released over the weekend put the LDP party on an approval rating of 39%, the lowest Shinzo Abe’s party has had since coming to power in 2012. To put this in perspective, only 9% of those surveyed said they would vote for Abe’s main rival party the Democratic Party of Japan. The concern here is that if the LDP party lose 20 seats or more, many will doubt whether Shinzo Abe has the backing needed to perform such radical measures. This invariably means JPY strength.

Technically, EUR/JPY is still in an uptrend, but it’s interesting to look at the fact EUR/JPY has closed above the five-day moving average since October 23. Yesterday, the pair closed below this level, although price is once again testing this level, so it seems the pair is at a critical juncture. The oscillators are topping out, but are yet to provide a clear sell signal.

I sense the pair will gravitate to the 38.2% retracement of the October to November rally at ¥143.40 in the coming weeks. A break here would suggest a deeper move below ¥140.00.

There are signs the pair wants to go lower, but the setup on the daily, weekly or monthly is hardly convincing for short positions at this stage. Still, this is a pair which is of great interest and certainly one to watch.

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