The Japanese Yen and its drivers

Global economic tensions brought back interest for the Japanese Yen (Risk-off environment), which was the only currency to perform against the greenback in January; and as some investors said: ‘the JPY carry trade is the only thing that matters’. According to the CFTC, traders have reduced their net short positions to -86.2 (000’s of contracts) in the week ending Jan 28 (from -115K in the previous Commitment of Traders report last week). The Gross yen position have been constantly reduced since Mid-December and we are now with 102.2K short contracts (vs. Long 16K long), closed to three-month lows.
USDJPY is down 340 pips since its high of 105.40 reached on January 2 this year and is now testing the 102.00 resistance again. The question is now: is there more room on the downside for this month of February?

In this article, we display a few charts that we like to watch before starting considering taking a position in USDJPY.

The first one is USDJPY (in black) versus the 10-year Treasury yield (in green).
Since policymakers pronounced the ‘QE Taper’ words last summer, LT yields have started to increase in the US bringing back interest for the US Dollar. Between November 1st 2013 and January 2nd 2013, the 10-year yield has surged from 2.6% to a high of 3.03%, pushing USDJPY up by 7 figures (from 98.40 to a high of 105.40). However, as you can see it on the chart below (30-min period), Risk-Off sentiment have ‘forced’ traders and investors to hold back the so-called ‘safe-haven’ assets such as US Treasuries and the Japanese Yen as fear has hit the market again in the middle of this global economic meltdown. The US 10-year yield was trading at 2.65% on Friday’s trading session, which means that we are now back at levels we saw in November last year.

The second chart that we like to watch is the correlation between USDJPY (in black) and the US equity market (in purple). In theory, when bond prices increase (i.e. yields fall), the stock market decreases and we start to see carry traders unwinding their positions. This chart shows how the US equity market (S&P 500 index) has reacted since it reached its historical high of 1,848 on December 31. As you can see it, the S&P 500 closed at 1,782.60 on Friday, down 3.57% since its December’s high (while USDJPY was down 3.22%). The 22-day correlation between the two underlying assets is now at 90%…

Another chart to look at would be USDJPY versus the Nikkei index. In the early London trading session, we usually have a quick look at the Asian fundamentals that came out overnight and watch how the equity market reacted then. It gives me an idea if it is worth considering holding a position in USDJPY in my book or not. When we see an agitated overnight session, it takes us a bit longer to decide entering either a short or long position.

Quick Technical Analysis on USDJPY:
The next support on the currency pair stands at 101.60 (December 5 lows). If USDJPY still continues to slide this week, the next level to watch on the downside will be 101.06 (its 100-day moving average), which we think the pair will hit before the NFP release next Friday.

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