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DailyFX Top Trade this Week – USDJPY Faces Risk and Rate Forecast Trends

USDJPY, Interest Rates, Volatility and Ukraine Talking Points

  • USDJPY represents one of the most amplified interest rate differentials amongst the major currencies while also catering to risk-related flows
  • Rate expectations for the Fed soared this past week, helped along by the US CPI and Fed speak; but warnings of an imminent invasion of Ukraine cut risk appetite and policy forecasts
  • A critical range stands for USDJPY between approximately 116.25 and 113.75 – a possible volatile range or loaded and eventual breakout candidate

There are some serious fundamental developments unfolding for the global financial system and the FX market is well-tuned to reflect on the uncertainties. The two principal themes that traders would do well to follow through the coming week is the constant evolution of global interest rate expectations (and particularly the Fed’s course) and the situation in Ukraine. On the former matter, we have seen interest rate expectations surge for many of the major central banks over the past few months as inflation has exploded. The US central bank has been the focal point of this theme though as the largest economy in the world and one of the most vocal hawks amongst its peers. Rate expectations have topped six full, 25 basis point hikes priced in through year’s end with speculation over a seventh. This is a stretched theme that is somewhat mature in its development. Alternatively, the situation in Ukraine is currently couched in warnings and fear of the next steps if Russia dos invade the country drawing a response from the West.

These two matters have very different influence over the bearing of USDJPY if they are both pushed further into heightened states. That said, more of the scenarios and potential impact in the different consequences tend to cater to a bearish view. Before speaking to the bearish paths forward, first the ideal bullish scenario would be a further escalation of US interest rate expectations and full relief in risk appetite – with further bullish charge. A break above 116.25/50 alone would not be convincing. I’d need to see that technical milestone alongside the fundamental backing. On the other hand, interest rate expectations for the US central bank will struggle to keep the pace of build up that we have seen over the past few months – a period which didn’t see much consistency in USDJPY climb. There is more potential (not probability but rather the market tempo should it occur) with a cooling of Fed forecasts. Similarly, a further retreat in risk trends mirroring the slide this past Friday would find the carry trade build up behind USDJPY unwind, while interest rate expectations would also likely deflate with a sentiment slide.

Chart of USDJPY with 100-Day Moving Average (Daily)

For the week ahead, it is more likely that we move in the general confines of the aforementioned 250 point range. That is a hearty enough span for many swing traders as we wait to see how the bigger issues unfold. That said, it is worth keeping tabs on the much larger technical picture. If you pull out to a time frame of weekly (or higher), you can better appreciate the pressure building on a larger scale. Breaking above 116.25/50 would push us above the upper boundary on a multi-decade symmetrical triangle pattern that would open up to previous swing highs that haven’t been seen in years – like 118.50 back in December 2016 or 125.75 touched back in June 2015. Again, on this higher time frame, a resolution to the downside would be the path of least technical resistance. A break below the 20-week moving average and channel floor around 113.75 backtracks into the range and slowly retraces the past few years of slow build up.

Chart of USDJPY with 20 and 50-Week Moving Averages (Weekly)

Taking a look at how retail FX traders at IG are gauging the situation, there is a strong net short view in their exposure measured by the IG Client Sentiment data. With just over 70 percent of the traders short to start the new week, it seems there was a lean against short-term 2022 double top around 116.25. Beyond that however, there has been a stronger and persistent short view on the cross since late September when we cleared 111.00. At extremes, this is often a contrarian reading; but retail traders’ typical trading style tends to suit range markets when they arise.

Retail FX Positioning of IG Clients in USDJPY (Daily)

This information has been prepared by IG, a trading name of IG US LLC. This material does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. You should not treat any opinion expressed in this material as a specific inducement to make any investment or follow any strategy, but only as an expression of opinion. This material does not consider your investment objectives, financial situation or needs and is not intended as recommendations appropriate for you. No representation or warranty is given as to the accuracy or completeness of the above information. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. Any research provided should be considered as promotional and was prepared in accordance with CFTC 1.71 and designed to promote the independence of investment research. See our Summary Conflicts Policy, available on our website.

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