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110 Breaks, How Low Can USD/JPY Go?

Published 2017-06-06, 05:40 p/m

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

No major U.S. economic reports were released Tuesday but the weight of recent data sent USD/JPY tumbling below 110. The decline was as much about the strength of the yen as the weakness of the dollar because risk aversion took all of the yen crosses lower. The greenback saw losses against all of the major currencies but USD/JPY took the brunt of the selling. Although we’ve said recent disappointments in U.S. data would drive the dollar lower ahead of next week’s FOMC meeting, traders need look no further than the persistent slide in U.S. yields for guidance. USD/JPY has taken its cue from the 10-year U.S.Japanese yield spread, which dropped to a 2-week low. Now that the currency pair is trading below the 100-day SMA and the key 110 level, everyone is wondering how much further it can fall. Fundamentally, the Federal Reserve is the only major central bank raising interest rates and another round of tightening is expected next week. However that move has been fully priced in and what investors care about is not what happens in June but what the Fed will do in September. In the near term, we won’t have any fresh insight as U.S. policymakers are in a quiet period before the monetary policy announcement. No news is bad news for USD/JPY as it discourages investors from buying the pair ahead of such an important event. Guidance is key and unfortunately, based on recent data and what’s NOT happening on Capitol Hill, the Fed has very little reason to pound the table for another quarter-point hike in September. And if we are right, the dollar could sell off rather than rise after next week’s rate hike. Technically, now that the April 24 gap has been filled, USD/JPY could slip to this year’s low of 108.13. Of course if the Fed looks beyond the recent slowdown in data and expresses its confidence that rates will need to rise again this year, the latest decline will be unwound quickly as the pair marches back above 110. There was one additional piece of news worth noting, which was the report that China is are ready to buy more U.S. Treasuries as the yuan stabilizes. Although the PBoC has been quietly scooping up Treasuries for some time, this explicit comment sent bond prices higher and yields lower. USD/JPY fell in lockstep with yields even though more purchases of Treasuries also means more purchases of U.S. dollars by China.

Tuesday's euro drifted higher on the back of stronger Eurozone data and the decline in the greenback.
We have seen a slow rise in the currency this week but further gains are expected leading up to and most likely on the back of Thursday’s European Central Bank’s monetary policy announcement. Data continues to improve with Eurozone retail sales rising 0.1% in April. Economists anticipated a slowdown but the uptick kept the year-over-year rate steady at 2.5%. The ECB is widely expected to upgrade its economic forecast this week but the big question will be how much concern President Draghi expresses about the strong euro and low inflation. Either way, 1.13 is the level to watch and it could break before the rate decision if Wednesday’s Eurozone GDP numbers are revised higher.

Sterling, on the hand, struggled to extend its gains during the NY trading session. No U.K. economic reports were released with Halifax house prices being the only piece of data due on Wednesday.
Thursday is the big day for the pound and we continue to believe that the pair will see more profit taking in the run up to the elections. The polls are close and the consequences too great if PM May’s party loses – we could see GBP/USD fall 2 to 3 big figures on a knee-jerk reaction but it would be interesting to see how quickly GBP recovers as some may hope for the reversal of Brexit. Chances are, though, that her party will win and GBP will rally in relief. Keep watching the polls as the results will guide the near-term path for pound sterling.

All 3 of Tuesday's commodity currencies traded higher with the New Zealand dollar leading the gains. NZD would have enjoyed an even stronger rally if not for the softer global dairy auction.
Although prices increased for the 6th auction in a row, Tuesday’s 0.6% increase was the smallest since March 7. The slowdown in price growth is not yet reflected in the Commodity Price Index, which rose 3.2% in May, up from -0.2% in April. Job ads and the first-quarter manufacturing index were due for release Tuesday evening. While interesting, neither one of these reports is expected to have a significant impact on NZD. Despite a significantly weaker-than-expected IVEY PMI report, the Canadian dollar traded higher against the greenback. Manufacturing activity slowed to 53.8 from 62.4, the lowest level since August of last year. This is a sign of headwinds in Canada’s economy but with oil prices rising 2%, investors looked past the softer release. Although the trend for USD/CAD is down, the drop in the IVEY PMI index and corresponding slide in the employment component suggests weakness for Friday’s labor-market report. If that’s the case, then 1.34 could be a good place to establish fresh longs.

As expected, the Reserve Bank of Australia left interest rates unchanged Monday night.
The Australian dollar rallied on the announcement even though the central bank said an appreciating currency would complicate economic adjustment. They felt that unchanged policy is consistent with meeting their inflation target and sustainable economic growth. They also saw labor-market indicators as mixed with growth in total hours worked weak but job growth stronger. This is a problem because slow growth in real wages is restraining consumption but these warnings seem to matter to AUD/USD traders who interpreted the central bank’s neutral stance as positive for the currency. Australian GDP numbers were due for release Tuesday evening and the big drop in current account had some investors fearing a softer release even though retail sales and trade activity ticked up in the first quarter.

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