USD/JPY reverses hard after BOJ disappointment, warning of potential top

USD/JPY has been highly correlated with near-term US rate expectations over the past three months
Market pricing for Fed rate cuts is starting to increase again
USD/JPY reversal on Friday warns of potential near-term top

Quick USD/JPY take

The large reversal in USD/JPY on Friday following the Bank of Japan (BOJ) interest rate decision could be the start of a far larger move in the weeks and months ahead, unless you think the Federal Reserve may be forced to abandon the prospect of rate cuts this year.

Given asymmetrical risks for the US rate outlook and increasingly tepid US economic data, selling USD/JPY rallies is preferred given how poorly it has traded around these levels recently.

Fed rate cut bets influential on USD/JPY

Interest rate differentials have long been a key driver of USD/JPY movements, but not over the past three months.

As shown in the chart below tracking the rolling daily correlation between USD/JPY and numerous market indicators, it’s been Fed rate expectations in 2024, proxied in this instance by the shape of the Fed funds futures curve, that has been highly influential on USD/JPY, sitting with a correlation of 0.85.

In contrast, the vice-like grip yield differentials had over the pair earlier in the year has all but been obliterated, suggesting it’s the ultra-short end of the US interest rate curve you need to be watching if you’re trading USD/JPY right now.

Markets favour two Fed rate cuts in 2024

While it can’t be described as definitive, it looks like the unwind of significant Fed rate cut bets earlier in the year has stalled, with traders now favouring two cuts from the Fed this year rather than one.

When you look at how spotty the US economic data has been, it’s arguable risks for the US rate outlook are asymmetric given how much easing has been stripped out as the higher for longer narrative took hold. The prospect of the Fed having to hike again looks extremely remote. In contrast, the chance of earlier cuts is building, adding to the risk the Fed may be forced to cut not only earlier but harder if activity starts to roll over.

USD/JPY reversal post BOJ noteworthy

Given it’s the USD side of the equation that dominates USD/JPY movements, it was surprising to see the initial reaction to the BOJ decision last Friday where it failed to announce a reduction in the amount of Japanese government bonds its purchases as part of its qualitative and quantitative easing (QQE) program.

Yes, there had been some speculation it may have made the announcement at this meeting. And delaying it by six weeks signals the BOJ is in no rush to normalise monetary policy settings further. But with expectations for further tightening so low, with not even two full 10 basis point rate hikes priced for this year, the move reeked of opportunism to initiate a stop run above 157.71, the highs hit in late May.

Once those orders went, it’s not surprising to see how quickly USD/JPY reversed.

Even before the fundamentals discussed above are taken into consideration, the price action alone warns of a potential near-term top that could grow to something far more significant should the Fed be forced to pull forward rate cuts.

USD/JPY shorts favoured

For those keen to take on the short USD/JPY trade you could sell around these levels with a stop above Friday’s high of 158.26 for protection. The initial target would be 156.55, a level that acted as support and resistance in May and June. Should that give way, the 50-day moving average and long-term upside support would be the end downside target. That comes across as a far harder test for shorts.

As ever, should the trade work in your favour, consider lowering your stop to entry level, providing a free hit on downside.

-- Written by David Scutt

Follow David on Twitter @scutty

How to trade with City Index

You can trade with City Index by following these four easy steps:

Open an account, or log in if you’re already a customer

• Open an account in the UK
• Open an account in Australia
• Open an account in Singapore
Search for the market you want to trade in our award-winning platform
Choose your position and size, and your stop and limit levels
Place the trade

This report is intended for general circulation only. It should not be construed as a recommendation, or an offer (or solicitation of an offer) to buy or sell any financial products. The information provided does not take into account your specific investment objectives, financial situation or particular needs. Before you act on any recommendation that may be contained in this report, independent advice ought to be sought from a financial adviser regarding the suitability of the investment product, taking into account your specific investment objectives, financial situation or particular needs.

StoneX Financial Pte. Ltd., may distribute reports produced by its respective foreign entities or affiliates within the StoneX group of companies or third parties pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Where the report is distributed to a person in Singapore who is not an accredited investor, expert investor or an institutional investor (as defined in the Securities Futures Act), StoneX Financial Pte. Ltd. accepts legal responsibility to such persons for the contents of the report only to the extent required by law. Singapore recipients should contact StoneX Financial Pte. Ltd. at 6826 9988 for matters arising from, or in connection with the report.

In the case of all other recipients of this report, to the extent permitted by applicable laws and regulations neither StoneX Financial Pte. Ltd. nor its associated companies will be responsible or liable for any loss or damage incurred arising out of, or in connection with, any use of the information contained in this report and all such liability is hereby expressly disclaimed. No representation or warranty is made, express or implied, that the content of this report is complete or accurate.

StoneX Financial Pte. Ltd. is not under any obligation to update this report.

Trading CFDs and FX on margin carries a high level of risk that may not be suitable for some investors. Consider your investment objectives, level of experience, financial resources, risk appetite and other relevant circumstances carefully. The possibility exists that you could lose some or all of your investments, including your initial deposits. If in doubt, please seek independent expert advice. Visit www.cityindex.com/en-sg/terms-and-policies for the complete Risk Disclosure Statement.

ALL TRADING INVOLVES RISKS. LOSSES CAN EXCEED DEPOSITS.

City Index is a trading name of StoneX Financial Pte. Ltd. (“SFP”) for the offering of dealing services in Contracts for Differences (“CFD”). SFP holds a Capital Markets Services Licence issued by the Monetary Authority of Singapore for Dealing in Exchange-Traded Derivatives Contracts, Over-the-Counter Derivatives Contracts, and Spot Foreign Exchange Contracts for the Purposes of Leveraged Foreign Exchange Trading. SFP is also both Derivatives Trading and Clearing member of the Singapore Exchange (“SGX”). SFP is a wholly-owned subsidiary of StoneX Group Inc.

The information provided herein is intended for general circulation. It does not take into account the specific investment objectives, financial situation or particular needs of any particular person. You should take into account your specific investment objectives, financial situation or particular needs before making a commitment to invest, including seeking advice from an independent financial adviser regarding the suitability of the investment, under a separate engagement, as you deem fit. No representation or warranty is given as to the accuracy or completeness of this information. Consequently, any person acting on it does so entirely at their own risk.

The information does not represent an offer of, or solicitation for, a transaction in any investment product. Any views and opinions expressed may be changed without an update. To understand the risks and costs involved, please visit the section captioned “Important Information” and the “Risk Disclosure Statement”.

The information herein is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation.

StoneX Financial Pte. Ltd. 1 Raffles Place, #18-61, One Raffles Place Tower 2, Singapore 048616. Tel: 6309 1000. Co. Reg. No.: 201130598R.

This advertisement has not been reviewed by the Monetary Authority of Singapore.