USD/JPY: The Big Zone is Almost Back in-Play

USD/JPY Talking Points:

• It was a little less than a month ago that the backdrop was bleak for USD/JPY, with the pair testing below the 140.00 handle.
• Bears couldn’t seal the deal, however, and a retracement began to show, with higher-lows printing even as the Fed cut rates by 50 bps.
• Now with price action breaking above a falling wedge and retracing more than 38.2% of the prior sell-off, there’s claims that the carry trade is back. But with the Fed widely-expected to cut another 150 bps or more by the end of next year, that argument doesn’t seem to fit the backdrop, explored further below.

As the old saying goes, price action often shapes the narrative. You didn’t have to look hard to find USD/JPY bears a month ago when the pair was testing below the 140.00 handle. But as I had noted in these pieces, the move was starting to look long-in-the-tooth as RSI divergence had appeared to go along with the build of falling wedge formations.

The week after that false breakout at 140.00 was populated by even more bearish behavior in the USD. EUR/USD quickly rallied back to the 1.1200 handle as the FOMC kicked off a rate cutting cycle but, interestingly, USD/JPY merely showed a higher-low on that rate cut announcement and continued to grind-higher. Eventually, the pair broke out of a falling wedge formation and then last week, when the USD posed its strongest weekly gain in more than two years, USD/JPY jumped higher-and-higher, leading many to the conclusion that the carry trade was back as strong US data nudged rate cut expectations.

While that strong US data in the form of Core PCE and NFP and even this morning’s CPI may have nudged rate cut expectations, they haven’t eliminated them, they’ve merely pushed them further out into the future. At this point the Fed is widely-expected to cut at least 150 bps into the end of next year, which would imply 50 bps more this year and another 100 next year. Traditionally speaking, four 25 bp rate cuts in a single year is a brisk pace and that’s what markets are looking for right now, even with US data coming out stronger than expected.

In USD/JPY, near-term price action has remained undeniably bullish as I looked at in the Tuesday webinar; and this probably explains some of that bullish narrative that we’ve seen. But – that doesn’t mean that the carry trade is back and, in my view, we’re fast nearing a moment of truth on the matter.

The 150-151.95 zone has had incredible pull on USD/JPY over the past couple of years. This was the spot that the BoJ defended in 2022, eventually leading to a 50% retracement of the prior 2021-2022 major move.

It held the highs again in Q4 of last year, leading to a 23.6% retracement of that same prior trend before buyers set the low at 140.30, and pushed right back in Q1 of this year.

USD/JPY Weekly

It was Q2 of 24 that finally saw a break as above-expected CPI in April pushed a fresh high, likely triggering a host of stops and leading to another extension up to the 160.00 handle. The response to that – found support right at 151.95.

Finally in July the whiffs of change began to show: The Bank of Japan intervened on the morning of a CPI print, and, at that point, it finally seemed like rate cuts were close in the US. That drove an aggressive move of USD weakness, likely some of which was driven by closure of longer-term carry trades.

But was the entirety of that move a defensive response from longer-term carry traders? Given the fast pricing-in of rate cuts there was probably the build of speculative short positions, as well, and this is something that I think has played a major factor in the pair’s behavior over the past month.

The weekly USD/JPY bar is similarly looking weaker than that of the DXY. While the USD has extended the prior week’s bullish run, USD/JPY is currently showing indecision inside of that 150 level on the weekly. And from the daily, we can see even more disparity as DXY is currently green as of this writing, and USD/JPY is red, indicating Yen-strength and USD-weakness even after a strong CPI print that brings to question near-term ability for the Fed to cut rates.

USD/JPY Daily Price Chart

USD/JPY Price Action: Where the Rubber Meets the Road

At this point we can’t quite claim bearish trends as price has continued to hold both higher-highs and higher-lows. But – there are hints of possible change. The same RSI divergence that I noted ahead of the reversal in August and September is now starting to show on the other side, with lower-highs on RSI even with higher-highs on price.

In early trade this week, as the USD was finding resistance at a confluent spot of Fibonacci levels – USD/JPY held support well at a zone of Fibonacci levels around the 148.00 handle. So, in my view, buyers still have short-term control of the matter.

But that could change if we see the 147.94-148.13 zone taken out, or if we see sellers make a fast return upon a re-test of the 150.00 handle.

If looking for bullish USD scenarios there simply seems to be more attractive venues elsewhere given this context of longer-term resistance lurking overhead.

Above 150.00 is the 50% mark of the sell-off at 150.77 and above that, the major level of prior BoJ defense at 151.95.

USD/JPY Four-Hour Price Chart

--- written by James Stanley, Senior Strategist