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The USD/JPY exchange rate has stabilised modestly in the past few days as some traders continue buying the dip. It bottomed at 141.77 on Monday and has pared back some of the losses, moving to a high of 147. Still, the pair remains significantly below last month’s high of 161.87.
Japanese yen carry trade
The USD/JPY exchange rate suffered a harsh reversal as investors focused on the actions of the Bank of Japan (BoJ) and the Federal Reserve.
For a long time, interest rates between the US and Japan were wide apart. Most recently, US rates were 5.50% while in Japan they were at minus 0.10%. This spread created an exciting carry trade opportunity as many investors borrowed heavily to invest in other countries, especially in the United States.
Now, the pendulum has shifted and the Bank of Japan has exited negative rates and boosted rates to 25 basis points. It did that in a bid to fight inflation, which has remained above 2% in the past few months. Watch here: https://www.youtube.com/embed/mK1A7iySl_k?feature=oembed
Federal Reserve cuts
The Federal Reserve, on the other hand, has hinted that it will start cutting interest rates, joining other banks like the Bank of England (BoE), European Central Bank (ECB), and the Swiss National Bank (SNB).
The odds of the US cutting rates have increased in the past few weeks after the US published mixed economic data. According to the Bureau of Labor Statistics (BLS), the country’s inflation has dropped in the past three straight months.
The headline Consumer Price Index (CPI) rose to 3.0% while the Personal Consumption Expenditure (PCE) inflation figure dropped to 2.5%. While these numbers are above the Fed’s 2% target, they are moving in the right direction.
The labor market, which is the other part of the Fed dual-mandate, is weakening, with the unemployment rate rising to 4.3%. Historically, the economy has moved into a recession whenever the jobless rate rises for five straight months.
Other economic numbers on labor productivity, manufacturing output, and industrial production have also been weaker than expected.
Therefore, the Fed is in a catch-22 situation. Failure to cut interest rates now would push the US economy deep into a recession. On the other hand, being aggressive in cutting interest rates would spur inflation.
Analysts have mixed opinions on what to expect when the Fed meets in September and when Jerome Powell speaks at the Jackson Hole Symposium.
Some analysts expect the bank will deliver a jumbo hike of 0.50% in this meeting followed by smaller 0.25% cuts. On the other hand, other analysts believe that the cut should start at 0.25% to prevent inflation risks.
Unwinding of the yen carry trade is not over
Therefore, the ongoing climb of the USD/JPY pair has seen some analysts predict that the unwinding of the Japanese yen carry trade has ended.
However, we believe that this trade is still entrenched in the market and that it will take time and cause more damage for a while.
It is still unclear how big the carry trade is. Analysts at Deutsche Bank believe that it could be worth over $20 trillion, a figure that is about 505% Japan’s GDP and even bigger than China’s GDP. I believe that this view is a big exaggeration.
A loook at data by the Bank of International Settlement (BIS) estimates that the carry trade is worth about $1 trillion while other figures point to it being 3.4 trillion yen. These numbers mean that the yen trade is massive and that it will take time to unwind.
USD/JPY technical analysis
USD/JPY chart by TradingView
The daily chart shows that the USD to JPY exchange rate peaked at 161.87 in July and has crashed hard in the past few weeks. This drop happened as the Bank of Japan (BoJ) started hiking interest rates and intervening in the forex market.
The pair has slumped below the 50-day and 200-day Exponential Moving Averages (EMA) and the two are about to make a bearish crossover. In most cases, this pattern is one of the most bearish in the market.
After falling sharply on Monday, the pair has rebounded from 141 to 147. This rebound happened after the pair formed a hammer candlestick, which is a sign of a bullish reversal.
The pair has retested the 38.2% Fibonacci Retracement point. At the same time, the Relative Strength Index (RSI) and the Stochastic Oscillator have pointed upwards and emerged from the oversold level.
Therefore, I believe that the USD/JPY pair is having a dead cat bounce and that it will resume the downtrend in the near term. If this happens, the next point to watch will be at 141.77, its lowest point this week. A drop below that level will see it drop to 140.
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