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Summary
- As we wrote last week, August seasonality has seen reduced market liquidity and rendered trading conditions suboptimal.
- This is especially true in USD/JPY, having a ~6% high/low range in the three trading days between 1 and 5 August.
- Expect another week of choppy, illiquid markets, with new direction in USD/JPY emerging only next month.
Market Implications
- We stand aside at least until next week’s US jobs report to avoid the August volatility.
- USD/JPY has struggled to regain durable upside traction after the recent bottom near 142 on 5 August. Therefore, at the margin, we prefer fading USD/JPY strength post-US nonfarm payrolls (NFP), although we have low conviction.
USD/JPY Has Had a Whipsaw August
As we wrote last week, the most recent US jobs report, released on 2 August, triggered sharp price moves across all asset classes.
USD/JPY moves were among the most striking. In the days preceding the release, USD/JPY fell from ~154 to ~149. On the day of the release, the pair fell another 1.9% and 1.6% more the next trading day (Monday, 5 August).
The low on 5 August, which still stands as the MTD low and lowest print since January, was 141.70.
USD/JPY then rallied above 149 (near the close on 1 August before the US jobs data) for the next week or two and has since grinded lower to currently ~144.50.
Chart 1: USD/JPY Spot Rate = Orange Line
Be Patient, Liquidity Should Improve in September
This whipsaw price action has many drivers, including US data and attendant Federal Reserve expectations, Bank of Japan monetary policy and messaging, and general risk sentiment.
We also argue reduced market participation, due to many traders and investors holidaying in August, exacerbated recent moves. Suboptimal liquidity meant market moves were more acute than normal.
July/August Slide Cleared Out Much Long USD/JPY Positioning
Yet August’s moves have materially impacted market positioning.
Last month, hedge fund (HF) and real money (RM) JPY net shorts were at extremes, as the carry trade was in full swing, USD/JPY was trading above 160, and additional upside in the pair seemed logical and inevitable.
Now, with USD/JPY over 15 big figures lower than it was in July, all that short positioning ended earlier this month, with HF and RM now having little or no JPY exposures.
If We Are Right About US Yields, Sell USD/JPY Rallies
The US yields down move is a key driver of USD/JPY downside this month.
Since close of business on 31 July, the 2-year US treasury yield is down about 40bps. From 3 July, when USD/JPY printed a 30+ year high near 162, the US 2-year is down about 85bps.
Chart 2: US 2-Year Yield = Orange Line
We expect further downside in US yields. A lot of Fed easing currently priced into the US short end is a caveat to this view. As such, we like to be patient, scaling into a long US rates position.
Although we think the broad trend is for more downside in yields, we are probably overdue a corrective counter-trend retracement higher.
Adding that to the suboptimal market liquidity, we prefer standing aside for the next week before initiating exposure.
This is true across all markets, including US rates and in FX (and specifically in USD/JPY).
Nonetheless, if we are correct about US yields continuing lower, we think this will also weigh on USD/JPY. Scaling into a position applies for the FX pair as it does for US rates.
Although our conviction is higher in our US rates view, we think lower US yields will mean the YTD trough in USD/JPY, near 140.00, could emerge in coming months.