Vantage FX | Japan Special, Nikkei and USDJPY look vulnerable | 28 May 2013

May 28, 2013

As expected the past 24 hours have been fairly quiet given that the US and UK were both out but equally as expected the Nikkei had another volatile day’s trade and USDJPY gives every sign that it has a further downside thrust coming.

So lets focus on Japan today because it seems that all roads flow from what is happening there at the moment.

Both the Nikkei and USDJPY have been on a massive bull run since late last year and both are showing signs that a reversal – or at least a pause – is in the offing. That is not to say it’s overdue, that’s not how we trade, but if I look at my usual chart patterns and indicators both the USDJPY and the Yen look like a further retracement is in the offing.

Looking first at the Nikkei it is clear that this 13944 region is support at the moment with buyers entering under 14000 on each of the last 3 trading days. Using my usual indicators it is worth noting that the Nikkei is below our fast moving average for the first time since April and has closed below for two days now which starts to turn the outlook. A break of 13950 looks to open the way for a test toward trendline support at 13,000/200 zone.

Looking at the USDJPY it looks biased to a test of 100 and should that break the trend line at 98.00/10 becomes the target.

The big question from a fundamental point of view is why might these well established trends reverse and the pretty easy answer is that sentiment is shifting a little, perhaps a lot, as to the impact of BoJ QE on Japanese yields and by extension the Japanese economy. Now it is important to note that the 10 year JGB closing in the low 0.80% region yesterday hardly endangers the recovery and our view is that the BoJ will sit on the rate until it feels its work is gaining traction.

As the chart above shows even though the absolute level of the 10 year JGB yield is not too bad in the context of the last fe years the down trend has clearly broken. Now of course if yields rise then this has every chance of choking off the recovery that is clearly in evidence but if inflation expectations are supposed to rise then surely the 10 year yield has to rise also.

So it is no surprise that the Minutes of the BoJ’s last meeting released yesterday showed that “a few members” were worried about signalling and the “contradictory” message of buying bonds and creating inflation sent. I read in Quartz this morning that RIchard Koo from Nomura,

read the selloff as a sign that the BoJ can’t keep yields down “no matter how many bonds it buys,” and that that could trigger a “loss of faith in the Japanese Government”

Now if that happens the very close nexus between the Nikkei and the Yens moves could be broken as the Yen sells off toward 150 on the loss of confidence and the Nikkei gets hit because yields are rising as the market loses faith in the BoJ and the Japanese Government and its debt level, changed current account circumstances and demographics.

One other thing to note for FX traders is that the market is very short yen at the moment with teh CFTC data showing net big spec shorts of more than 95,000 which is a 12 month low. SO there is room for this USDJPY reversal.

Taking all of the above into account I’d rather buy the dip on the USDJPY when it comes than buy the dip on the Nikkei.

Today there is little important data out but teh Aussie remains under pressure and I’d expect that over the next few days it will retest below 0.96 to see if the support is still there. Last nights low was 0.9613.

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