Make or break time for GBP JPY bulls

The big “risk-off” trade over the last couple of weeks has taken a bite out of many markets, but perhaps no widely-followed instrument has been hit as hard as GBP/JPY. Just before Christmas week, the historically volatile pair was trading up around 183.00, at roughly the same level as it was exchanging hands back in late August.

Over the last three weeks though, the bottom has absolutely dropped out and GBP/JPY is trading nearly 1000 pips lower. More worryingly for GBP/JPY bulls, the exchange rate is now below previous support from Q1 2015 at 175.00, suggesting that a long-term top may have formed. Naturally, the question on all traders’ minds is “when will the selling stop?”

In short, pound won’t find a bottom until risk sentiment stabilizes and traders grow more optimistic about the prospects for the Bank of England raising interest rates. The first condition is straightforward: if and when traders grow more optimistic about the prospects for the global economy, they’ll feel more comfortable investing in the currencies of countries with hawkish central banks.

The second condition is the crux of the issue right now though. After a string of rather “meh” data from the UK, including a disappointing jobs report and yesterday’s weaker-than-anticipated Manufacturing PMI reading, many analysts expect the BOE to remain on hold until late this year, with some expecting no change until early 2017. While the BOE would typically follow in the Federal Reserve’s footsteps, the lackluster economic performance and fears over a possible “Brexit” (UK exit from the EU) vote later this year has the central bank exercising caution. For more on BOE policy and what it may mean for the pound, see my colleague James Chen’s note, “GBP/USD Potentially Targeting Long-Term Lows below Key Support.”

Turning our attention back to GBP/JPY, bulls can make a case for a near-term bounce with rates deeply oversold (the daily RSI indicator is below 15, its lowest reading in years). That said, the longer-term technical and fundamental trends seem to support fading any counter-trend rallies as long as rates remain below previous-support-turned-resistance at the 180.00 area. To the downside, psychological support at 170.00 could be in play if we don’t see a bounce this week.

Unless we see a sharp reversal at the 175 level, things seem likely to get worse before they get better for GBP/JPY bulls.