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Safe haven flows can strengthen the yen

Posted on: 04 February 2019 , by: Darren Sinden , category: Market Review

Trend: Dollar yen could fall further as markets adjust to a new plan for US interest rates

A volatile start to 2019

Dollar yen found itself at the centre of a flash crash at the start of the New Year. Even though it rebounded from the lows posted then, the pair has looked tired throughout January.

The are two reasons why dollar yen hasn't rallied further:

  1. Changing investor sentiment towards US interest rates. It's now unlikely to rise in the first of 2019, or perhaps for the rest for the year.
  2. A flow of funds into safe-haven assets such as the yen. Investors and traders are hedging their bets based on concerns about global growth, US-China trade wars and an ongoing slowdown in the Eurozone economy.

After ten years of expansion and bullish sentiment, markets have to reassess the route map ahead and assumptions about continued growth in the US and higher interest rates are being left by the wayside.

The US economy may be hiding something

It may now be that US monetary tightening is behind us and that is something the market finds quite scary. Because, as economist Daniel Lacalle neatly put it, in a post after the most recent FOMC meeting

‘An economy that cannot take 3% rates with 3.7% unemployment and 3.4% annualised growth rate is not a "strong economy”.’

The question traders are asking themselves is, ‘Is the US economy harbouring some unpleasant surprises?’

Of course, turning points in sentiment such as this create opportunities for traders, and one of these maybe emerging in USDJPY or dollar yen.

Overseas influences on the yen

Looking at the recent data and newsflow from Japan you'd be forgiven for thinking that you should be selling the yen.

Remember that the higher the USDJPY rate, the weaker the yen is and vice versa. If we believe the dollar will strengthen, we buy dollar yen looking for a rise in the rate or if we believe that the yen will gain, we sell the pair looking for it to fall to a lower rate.

However, we need to remember that the yen is a highly liquid, global reserve currency backed by a credible central bank. That means that international capital flows into the yen and yen assets during times of uncertainty because investors are confident that can get their money back, as and when it’s required.

At times, these external relationships play a more significant role in the pricing of dollar yen than the Japanese economy does and this looks to be one of them.

Recent price action

The flash crash and rebound in early January grabbed all the headlines. Those moves were likely down to the placement of outsize orders, in thin trade, during an extended Japanese New Year holiday and we need to view them as such. It's what happened after that interests me:

 

USDJPY

The four-hourly chart above shows dollar yen struggling to trade above 109.80/90 throughout mid-January, and on two occasions in the latter part of the month, the rate tested to and rejected at a downtrend line (drawn in green) that dates back to December 2017.

It’s a line that has remained unbroken since then. The most recent interaction with the downtrend came last Wednesday, after which dollar yen sold off, then broke through and stayed below support circa 109.10 and the round number of 109.00.

What could we expect to happen from here

Dollar yen is seen as a strong bear within my model, one of only three such trends among the dozens of crosses and pairs it tracks. What's more, that bear trend is longstanding at just over ten-months-old dating back to mid-March 2018.

Much like the downtrend line on the chart above, it’s resisted any attempts to reverse it during that period.

The model, which is medium to long-term in its outlook, has a price objective for dollar yen down in double figures, though we’d need to see significant turmoil in the markets, as we did in 2010/11, to get there.

However, there’s scope for a move back to the 15th of January low at 107.98 and the 4th of January low at 107.51 and 107.22 after that, though RSI14 for dollar yen, on its four-hourly chart, is at 30 as I write. Even outside of the flash crash, it’s recently been as low as 20, so it can overextend to the downside from here.

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