Failing to break 100 four times in a row The market, and probably the BoJ, are nervously eying USD/JPY at 100 as a key level that can decide the next trend. Since June, the FX rate attempted to break this support no less than four times but failed every time (Graph 1).
Importantly, these failures happened on the back of disappointment regarding the outcome of central bank meetings, where either the Fed indecision to hike or the lack of BoJ decisiveness pressured the USD/JPY downwards. In particular, the market bid the yen when the BoJ did not cut rates but marginally expanded QE, and lastly when the central bank introduced its yield control framework. The looming US election might be a future trigger, but, arguably, the market could now legitimately believe that after having missed neat and repeated opportunities to break lower, the USD/JPY is now unlikely to eventually experience such a move.
Lagging Treasury yields and boosted by oil gains Since the beginning of last year, US long rates have again become the main USD/JPY driver. The BoJ’s peg on JGB yields is going to kill yen rates volatility, so that the rates factor should become even more US-centric. But the mild Treasuries sell-off right after that, which saw 10y yields briefly trading below 1.40%, was not enough to lift the US dollar. At the same time, the FX market challenged the BoJ, so that USD/JPY and US yields diverged (Graph 2). This correlation is notably unstable, but the mean-reversion between FX and rates has been powerful over recent years. US rates are now unlikely to drift much lower and should not precipitate a USD/JPY break, meaning a catch-up higher is a more likely scenario. The current relationship suggests a move above 105.
Softer options positioning may pre-empt an unwinding of yen longs. Positioning in spot and options markets tends to evolve in tandem, even if options investors are expressing views with a conditional nature. Since the CFTC records futures positions, the current long yen positioning has only been matched by the 2008 peak reached when Bear Stearns collapsed. Such an extreme positioning is hardly sustainable, and the softer skew in yen options markets might be sending the signal that longs are eroding (the 3m risk reversal is decoupling from futures positions). On top of that, OPEC’s surprise announcement of production cuts is supporting risky assets, instating a risk-friendly environment (higher stocks and commodities), which should further discourage yen longs.
In other words, USD/JPY is consolidating at the end of the funnel, and cannot stay trapped at the same time above 100 and within its channel beyond mid-October. A break either way is therefore ‘programmed’ for the next two weeks, with our analysis above favouring the topside.
**SocGen maintains a long USD/JPY position in its portfolio from 100.30.
This trade is tracked and recorded in eFXplus Orders.
Copyright © 2016 Societe Generale, eFXnews™
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