JPY Moves Lower Following US Elections

After strengthening sharply over the majority of the year, the Japanese Yen has now settled into a weakening trend brought about by the election of Donald Trump as the new US President alongside rising global bond yields.

JPY strength over the first 9 months of the year was largely responsible for downward pressure on global bond yields creating a negative feedback loop whereby JPY strength subdued domestic inflation expectations and made the BOJ’s QE program seem ineffective. This, in turn, fueled expectations that the BOJ would have to employ yet further, more unconventional action, in a bid to combat deflation. Each time the BOJ disappointed markets JPY then strengthened and domestic investor confidence plummeted.

Japanese QE drove more domestic purchases of foreign bonds as yields fell below zero, placing further downward pressure on global yields and thus creating less yield disadvantage for JPY. The deterioration in global confidence in the effectiveness of low yield’s ability to stimulate growth fuelled large safe-haven demand for the Yen with the search for yield causing strength in higher yielding currencies such as NZD.  Alongside this we saw falling domestic inflation expectations raising real yields in Japan which leant further support to the Yen.

BOJ Breaking The Cycle

It now appears that this negative feedback loop has finally been dismantled. The BOJ have shifted their emphasis onto yield curve control which so far seems to be working effectively in an environment of rising global yields. As yields strengthen, the BOJ can purchase more bonds as well as increase the duration of their purchases and can even start to sell shorter-term bonds to purchases longer-term bonds. Consequently, the USD/JPY 10y yields advantage has spiked to now testing the 2013 high whilst the 2y yield spread is at its highest level since 2008.

The cap in domestic yields alongside a weaker currency are likely to fuel an increase In Japanese inflation expectations and a decrease in real yields. Consequently, monetary policy now appears to be working much more effectively, and there no longer appears to be a problem for the BOJ in sourcing bonds to meet its QE purchase target.

Institutions Remain Long

The rise in JPY despite the aggressiveness of the BOJ’s monetary policy highlights the overbought nature of the currency. Despite this, institutional positioning reflects that the market is still net long the Yen indicating that there is plenty of room for downside in the currency as traders start to square positions. As the market starts to appreciate the BOJ’s policy and its growing effectiveness we are likely to see a much deeper correction in the Yen. When considered in the context of current and forecast USD strength in the wake of the Trump election, clearly USDJPY has a lot of upside potential.

Following the US elections, USDJPY has broken out above the 6-month range that has held price. The rally has now taken price into a key technical juncture with rate currently testing the top of a short-term bullish channel, the descending trend line resistance from late 2015 highs as well as the 38.2% Fib retracement from last year’s highs. Bulls will be looking for a sustained breach of this zone to signal further upside.

Data Flash

UK earnings and employment data for the 3 months through September were broadly flat. Average Weekly earnings remained unchanged at 2.3%, undershooting expectations of a rise to 2.4%. However, the Unemployment rate fell back to 4.8% from 4.9% prior marking new 10 year lows.

GBP/USD is still grinding higher in a short-term bullish channel, currently around the closing level of the day of the GBP “flash crash”. The next key resistance comes in at 1.2796/1.2873 at the broken post-Brexit support.