Today’s US employment report saw the bottom coming out of the US treasury market. This widened the yield spread between higher yielding US debt and lower-yielding Japanese government bonds and encouraged another leg higher in the USDJPY rate. As well, the somewhat stronger US employment numbers encourages the idea that the Fed will slow its asset purchases, perhaps as soon as this September, at the same time as Japan has launched a radical monetary easing experiment that won’t change any time soon. All supportive of the USDJPY higher, especially as the ECB and BoE also came out on the dovish side this week, leaving the greenback at the top of the heap of G-10 currencies.
Still, there is an ongoing risk of a USDJPY correction if asset markets turn tail and sell off steeply again. There is a strong risk of an ugly asset market correction – even if the economic data in the US does well enough to support the idea that the Fed will soon look to reduce the rate of its asset purchases, in fact, that’s likely to be the very cause of a correction in equity markets. That’s because asset markets over the last several years have become entirely dependent on central bank liquidity rather than economic fundamentals for their strength. Slow the liquidity and stocks will drop, and the JPY has been the most popular carry trade short since late last year as equity markets have rallied. Still, for the JPY to get more traction, we would need for not only an equity market correction, but a stable and even rallying bond market, because the heavy public debt burden in Japan makes the market nervous about the stability of the country’s debt.
From a technical point of view, the argument in favour of a USDJPY correction is a bit more straightforward. The idea here is from Elliott Wave Theory, which argues that significant market corrections are usually three-wave affairs. For USDJPY, the first, or A-wave was the one that took us from 103.00+ all the way back down to just below 94.00 before we witnessed the last surge higher to 101.00+ thus far, which is second, or B-wave. In extremis, an irregular correction B-wave could see the pair edging to new highs before the third wave, a downward C-wave, is established. That C-wave could take the pair as low as 92.00 or so, or wherever the 200-day moving average is trading in the event it heads back lower. A base case C-wave correction (assuming today’s price is the top) with a 100% extension would target about 91.20, while a 161.8% correction would target an eye-watering 85.00.
Chart: USDJPY
• Now, we’re getting ahead of ourselves a bit too much on a day when the US dollar is exploding stronger, so let’s look at a few things to look for that would tip us off to the potential that a B-wave top is in and that we are headed for a completion of the correction sequence with a sizable C-wave.
• First, we need a good pattern reversal that sees a strong rejection of the new highs here and a close back through perhaps 100 – watch the upper envelope of the Ichimoku daily (not far above today’s highs) for possible initial resistance.
• Second, a move back below the 55-day moving average (currently around 99.25) would also encourage the idea that a B-wave top is in place.
Third – if the bottom of the Ichimoku cloud – currently around 98.15 gives way, this could be a strong continuation signal for the pair.
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