USD/JPY - watching the big break here

As the market contemplates the likelihood for extended trade tensions and the Fed’s support, the expected downward pressure for USD/JPY may well be a trend continuing here.

Risk off on trade tensions

Following the eruption of trade tensions in a significant manner in May, markets had largely whipsawed through the month amid the uncertainties. A few agitated tweets from President Donald Trump had been tailed by the exchange of tariffs, whereupon China’s latest implementation of tariffs on US goods fell into place at the start of June. USD/JPY, which had been trading broadly rangebound between $108 and $114.60 since 2017, short for a brief period in early 2018, can be seen driven down to the lower bound of the range into end-May on the back of this heightening risk-off sentiment.

Moving into June, however, we have continued to see the picking up of trade tensions that spells further likelihood for the search for safety. Beyond China, the US can be seen invoking the market’s wrath with various other trading partners such as the Mexico and India. The materialisation of tariffs on Mexico goods would translate to the US engaging in a tariff scuffle with two of their top three trading partners of late. Moreover, President Donald Trump’s rhetoric on China had been little changed suggesting once again this week that tariffs on China could be raised by another $300 billion if necessary. Amid the lack of trade talks between the two countries, the potential G20 meeting between the two Presidents may also be at risk altogether pointing towards further evasion to safety for the market and further yen strength.

Yield differentials drag for USD/JPY

Meanwhile, there are perhaps little doubt that the US monetary policy had moved into the picture in a big way as a theme to drive markets. Fed chair Jerome Powell joined the echo of voices in suggesting that the Fed will be ready to move to sustain the economic expansion, against the earlier staunch patient attitude. For a market currently pricing in two rate cuts by year-end according to the CME FedWatch tool, this alignment by the Fed had certainly lit a fire under the markets.

The broad equity market space can be seen looking to adopt a more rangebound pattern amid the opposing forces of trade tensions and expected Fed support, though the factors both broadly backs further USD/JPY downsides. On the monetary policy end, expectations for an interest rate cut to come along and economic impact from the trade tensions had suppressed yields, sending the US 10-year treasury yield down to the lowest level seen since Q3 2017 in early June. This diminishing differential between US treasury yields and JGBs, as shown in the chart below, thereby further feeds into USD/JPY downsides.

Source: Refinitiv

Trading USD/JPY towards March 2018 lows

With all the above said, watch a pullback for USD/JPY towards the March 2018 lows given the abovementioned forces. The $108 level serves as a strong support at present, so look to a firm break below the level to re-ignite the trend, locking in the profit should prices hit the zone prior to the $105 level. A more conservative target level can be set at $106.

Geopolitics sits at the centre of this trade and just as the eruption of tensions came by suddenly, it may also be resolved quickly if some middle ground can be reached particularly between that of US and China. While this may be a stretch at present given the lack of talks between the two parties, the risks is not absent in totality. A reversal above the $110 handle may point to the resumption of the uptrend and thus indicative of an exit of the short position.

Source: IG Charts

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