USDJPY Reacting To Risk Sentiment Volatility

Aug 15, 12:25 pm

JPY Striding High Against USD

JPY strengthened sharply last week due to an acute increase in geopolitical tensions between the US and North Korea, which fuelled a safe-haven bid in the Yen. Upside movement has been exacerbated by the extreme level of bearish positioning in JPY, which is vulnerable to further reduction. On the week, JPY rose over 1% against USD, making it the best performing G10 currency as the continuous stream of headlines linked to the US/NK situation kept risk appetite constrained.

JPY’s status as a safe-haven currency means that it is particularly vulnerable to volatile moves during the period of geopolitical uncertainty leading to appreciation during risk-off time and weakening during risk-on times. As the situation between the two countries remains highly fluid, we are seeing very reactive price action with JPY weakening at the start of this week as tempers appear to have died down somewhat. However, the balance of risks suggests that JPY is likely to remain broadly supported in the near term.

Options Market Reflects Risks

Indeed, the options market reflects a cautious tone among market participants as implied volatility for JPY has increased across a range of time horizons. Risk reversals have of course moved in tandem, currently moving to price a stronger premium for protection against JPY strength (USDJPY downside).  The 3-month rate of change in JPY actually highlights that the currency has underperformed among its G10 peers during the recent phase of Dollar weakness. CAD & EUR have both moved around 10% over the three-month period, however, JPY is not yet showing signs of exhaustion and therefore further upside appears likely.

Consider Seasonality

Seasonality is an important consideration for assessing JPY direction as we are entering a period which has typically yielded JPY strength. August-October has often seen elevated volatility and increased turbulence in markets tending to benefit safe-haven assets such as JPY.

Positioning Suggests Short-Squeeze Risk

JPY’s vulnerability to sudden strength is exacerbated by the current level of short positioning in the currency which is the largest held net-short, as shown in the recent CFTC COT report. Gross shorts in JPY have recently moved to their highest level since 2007 with over half of the gross short position in JPY having been established since mid-June, during USDJPY’s rally from around 110. With USDJPY having now reversed and broken back below 110 there is the strong risk of a deeper short squeeze developing.

Regarding rate differentials, the current flight to safety is causing a narrowing of US-JP bond spreads as money flows into the US Treasury market. On the domestic level, the BOJ’s policy of yield curve control has been effective at capping JGB bond yields, despite an environment of rising global yields

Technical Perspective

USDJPY has been moving in a contracting triangle pattern over 2017 but broke below the pattern in response to last week’s escalation in geopolitical concerns. After breaking below the rising trend line of the pattern, price tested the June low and had subsequently reversed and bounced higher. Price has subsequently broken back inside the triangle pattern suggesting that the current 108s – 114s range is likely to continue, with price rotating back up into the top of the range.

However, with the geopolitical environment in such a precarious state downside risks remain. The key pivot for USDJPY is the 108.16 level which is the current 2017 low, a break below this level will pave the way for a deeper correction lower, bringing the 103.70s symmetry objective into focus.

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With over 6 years’ experience analysing currency markets, James is now a well-known industry analyst focusing on price action trading and fundamental drivers. Beginning as a private retail trader, James developed a strong interest in understanding the fundamental aspect of the market before pursuing technical trading capabilities which he now uses to identify opportunities over a short-term horizon. Alongside his market experience, James is also IMC certified having achieved the qualification to help further his understanding not only of the markets but the industry as a whole. James has a strong interest in both fundamentals and technicals and uses both forms of analysis in generating and executing trade ideas, with trades generally lasting from a few hours to a few days.