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USDJPY approaching support

We’ve had a very good run up in risk assets since February last year. As far as the major US stock indices are concerned there have only been two sharp, but brief, pull-backs since then. One came last June after the UK voted to leave the European Union while the second came in the immediate aftermath of the Trump election victory in November last year. In the latter case the sell-off in risk assets lasted little more than a few hours and it wasn’t long before the major US indices surged on to make a succession of fresh record highs - the last occurring in the NASDAQ100 this time last week. 

But investors are showing signs of nervousness now and there are a combination of reasons. Firstly, the US Federal Reserve looks set to continue to tighten monetary policy. But rather than concentrating on pushing up its Fed Funds rate at a steady and measured pace, it has just made it clear that it is prepared to start reducing its balance sheet later this year. This is a bit of a problem for investors as no one has yet worked out what a 0.25% rate hike is equivalent to in balance sheet reduction terms. On top of this, there is also a concern that the Fed may be raising rates just as the strength of US economic growth is being thrown into question. The latest Atlanta Fed forecast for first quarter GDP points to an increase of just 0.6% - well below the 2.1% increase in the fourth quarter of 2016, and miles below President Trump’s target of 3% plus growth.

Then we have the Trump administration’s promises on tax reform and infrastructure spending. Ever since the failure to push through the House the repeal and replacement of Obamacare, Trump’s fiscal stimulus measures are looking less and less likely to pass through Congress. This has led many investors to question the validity of the stock market rally since November.

And now we have this sudden escalation in geopolitical tensions, triggered by last week’s US missile strike on a Syrian airbase. The bellicose rhetoric has risen on all sides and we now have a number of financial markets reacting accordingly. Equity markets have pulled back from their best levels (but not by much) while oil and gold are pushing higher.

Now one of the most useful barometers of the “risk on/risk off” trade is the USDJPY. This is because when market sentiment is positive investors typically borrow (sell) the ultra-low yielding yen and use the proceeds to buy higher-yielding and riskier assets. This sends the yen lower so the USDJPY rallies. But when market sentiment sours, the trade is reversed as risk assets are sold and the borrowed yen are then bought back, pushing up the value of the currency.

Here is a daily chart of the USDJPY. I’ve drawn on a Fibonacci Retracement from the low which immediately followed Trump’s election victory to the high just five weeks later. As we can see, the area around 110.00 is quite critical as it represents the 50% retracement of the Nov-Dec rally. A break below here would suggest that investors are beginning to doubt the wisdom of the “buy the dip” trade that has worked so well for so long.

https://www.spreadco.com/assets/11.04.17.png

Disclaimer:

Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Category: PM Bulletin


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