After an astonishing burst in value following the election of Donald Trump, the US dollar reached a price of ~118.50. This leap higher was commonly seen as a response to Trump’s promise of de-regulation, lower taxes and pro-business policies that would altogether drive up the demand for the greenback. Analysts could argue that the price action was actually the retracement of a previous drop lasting almost the entire year of 2016, boosted by good US economic data, but in any case, the move higher was drastic and shook out many of the speculators shorting the dollar.
The USD/JPY price action since maxing out in December is worthy of investigation. The pair seems to be settling and trending downwards, but the next move could be binary as the pair also exhibits priming characteristics. A convincing move in either direction has large implications for markets beyond currencies. The main drivers facing the yen is risk appetite and demand for the higher yielding US dollar and US fixed income assets.
If the currency continues to move down, then analysts and pundits may begin to assert that financial markets are hedging and prepping for a risk-off environment – this will be characterized by a fall in asset prices such as those in stocks and properties and a reach for safe-haven assets such as the yen. If the USD/JPY and particularly the AUD/JPY price drops suddenly, this may be an indication a crash is imminent. This rationale is formed in the backdrop of monetary tightening, stretched stock market valuations and recent concern that the Trump trade is all air and no substance.
Conversely, it may be viewed that USD/JPY drift down is actually the pair winding up for another burst up, like the quiet of a coastal swell before launching a wave towards the coast. In this context, the drift down to ~110 is, in fact, the retracement of the retracement of the retracement and that the larger picture remains in place – that inflation remains low in Japan and BOJ’s monetary policy remains unchanged while the US is raising rates in line with healthy economic data.
Importantly, forecasters should never underestimate the potential demand for US bonds by Japanese investors with access to almost free money. For example, the demand for Australian bonds by Japanese investors are considered a main factor behind the persistent higher-than-fair-value price of the Aussie dollar - even after the deflating of the mining boom. A re-direct of this capital flow towards the USA as the Fed makes good of predictions it will raise rates another two to three times this year will surely give lift to the USD.
After taking into consideration bearish and bullish arguments, looking at the USD/JPY chart’s technical indicators will provide all the necessary signals in a fragile economic environment. A confluence of historical support at ~110.00 should provide the necessary base from where the USD/JPY can push higher - backed up by an encouraging MACD crossover. A fall below the converging support levels will prove ominous for global markets. A sharp spike down will indicate it’s time to consider moving into cash or other conservative assets immediately. A likely scenario is that current optimism will encourage investment for the time being, though one gets the suspicion it will only take a couple more straws.