by Pinchas Cohen
Widening Interest Rate Differentials Weigh On The Yen
The Federal Reserve raised the target range for the Fed funds rate by a quarter point to 1.5 percent during its December 2017 meeting, citing the labor market's continued strength and rising economic activity. The central bank has raised rates three times this year, five times since 2006. The Fed forecasts three rate hikes in 2018. Goldman Sachs, however, expects a tight U.S. labor market and more normal inflation will lead the Federal Reserve to hike interest rates four times next year.
In contrast, yesterday the Bank of Japan held rates at -0.1 percent as was expected. As well, Governor Haruhiko Kuroda said there’s no need to reconsider the current economic policy framework. Policymakers also kept Japan's 10-year government bond yield target around zero percent and offered a more upbeat view on private consumption and capital expenditure.
The BoJ has yet to raise interest rates since the 2008 economic crisis. In fact, on January 28, 2016, the central bank reduced its rate below zero, rattling global markets by adopting negative rates, more than 18 months after the European Central Bank became the first major monetary institution to venture below zero. This came after the Fed increased its rate six weeks earlier on December 16, 2015.
After yesterday’s BoJ meeting and Kuroda’s reiterating that that there are no rate hikes on the horizon, the yen extended a decline, following Tuesday’s biggest drop in almost two weeks. Today, the dollar is on course for its third day of gains against the safe haven currency.
What’s surprising about this 0.82 percent decline since Tuesday, or 0.98 percent decline since Friday, is that it’s happening against a stock selloff, which normally would send the yen jumping. Gold, for example, advanced 1.04 percent since Friday, and the yen has overtaken gold as perhaps the most popular safe haven asset. This only underscores just how bearish traders are right now on the yen, as a result of the widening interest rate differentials, to which there is no end in sight.
The Technicals Offer A Contrarian Perspective
The dollar-yen pair has been trading within a falling channel since November 6. A channel is drawn by connecting the highs and lows of the price action. The channel-top is the actual downtrend line, forming the resistance of sellers. The channel-bottom is the support line, where buyers come in. The fact that the channel is falling visually demonstrates that sellers outweigh the buyers, leading the channel down. Still, there is enough demand to form the support line, or prices would simply fall in a vertical line.
Nevertheless, buyers also believe that the main trend for prices is down, as they are unwilling to buy the pair again at the same price but “demand” a lower price. While it may seem obvious that sellers believe the price is heading down or they wouldn’t sell, what isn’t obvious is how far they think the price will fall. The fact that they can’t wait for the price to rebound to their prior selling point, but are selling at lower prices on rebounds, demonstrates that they think the price will go down even further.
So, while the fundamentals point to a weakening yen on interest rate differentials, the technicals are signaling a stronger yen.
'Hidden' Fundamentals
So why would the yen strengthen when the interest rate differentials are clearly in favor of the greenback? Some less obvious reasons:
- The Treasury selloff – the flat yield is causing sleepless nights for institutions. The Fed’s Kaplan said Tuesday that this likely signals a coming recession.
- As mentioned above, the yen is still the favorite haven asset. Therefore a market correction should send the yen flying.
Trading Strategies – Short Position
Conservative traders would wait for a trend confirmation, when a new trough, lower than the former, 110.83 posted on November 27, is registered.
Moderate traders may wait for a trend confirmation for a lower price than the 112.03, registered on December 15, or at least for a down-day that covers the body of the last up-day and preferably for it to fall below the short-term uptrend line since that December 15 trough.
Aggressive traders might rely on the expectant supply of the channel-top and former peak, at 113.75, registered on December 12 and take advantage of a very small risk, as the price returned to the resistance area, with a disproportionately favorable potential reward.
Equity Management
Stop-Loss: above 113.75, prior trough
Targets: 112.03, December 15 low; 110.83, November 27 low.