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Summary
- Last week’s Japanese election saw the current ruling coalition lose its majority, starting a rare period of political uncertainty in Japan.
- Following very choppy price action, USD/JPY initially moved higher this week on this uncertainty, but now trades back near pre-election levels.
- The Bank of Japan (BoJ) kept rates on hold today but reaffirmed further monetary policy tightening is coming and referenced recent JPY weakness as an issue.
Market Implications
- We still favour USD/JPY downside, with technicals near overbought levels and threat of Japanese Ministry of Finance (MoF) intervention and BoJ policy tightening looming. However, we remain very cautious in initiating market exposure.
- With the massive event risk to come in the US jobs report, US election and Fed policy update, it is too soon to initiate full short positioning.
- As outlined last week, we are patient and prefer scaling into a USD/JPY short slowly given the upcoming event risk.
USD/JPY Bounced Slightly After Japanese Election
Our piece last week highlighted our preference for USD/JPY downside but flagged the Japanese election as a material event risk.
Our concern last week was that a messy election result could lead to additional JPY weakness.
And so it did, initially.
USD/JPY traded as high as ~153.90 earlier this week but has reversed those gains to trade back near the closing level seen last Friday before Sunday’s Japanese election (Chart 1).
BoJ Stands Pat, but Messaging Weighs on USD/JPY
Earlier today, as expected, the BoJ kept rates on hold at 0.25%.
However, BoJ messaging in the press conference took USD/JPY sharply lower.
BoJ Governor Kazuo Ueda sounded a slightly less cautious tone about further monetary policy tightening than he had after Japanese market volatility in the summer.
In previous communications, Ueda said the BoJ had ‘time so spare’ before hiking rates again.
This time, Ueda seemed more decisive about further monetary policy tightening, veering from the previous ‘time to spare’ language.
The net impact on BoJ expectations from Ueda’s language shift saw the December and January meetings become ‘more live.’
Both dates now priced an additional 2bps of tightening, with ~8.5bps for December and ~17bps for January.
Ueda also said he wanted to judge the impact of the weak yen on the economy.
Coupled with last week’s MoF verbal interventions , the message is clear – Japanese officials closely watching what has happened to JPY this month, and that yen weakness is seen as an issue.
USD/JPY Technicals Remain Stretched
The recent USD/JPY rally has caused the Relative Strength Index (RSI, a key technical indicator) to stretch to the upside.
The USD/JPY RSI nears a level signalling the pair is overbought.
We like RSIs because they are a ubiquitous and simple technical indicator. By this, we mean the 30/70 rule.
When an RSI breaches 30 on the downside, the security is oversold. And, conversely, when an RSI breaches 70 on the upside, the security is overbought.
This week, the USD/JPY RSI printed above 70, and remains near that level, indicating USD/JPY is overbought (Chart 2).
The USD/JPY RSI has become less overbought with today’s sell-off, but continues near the overbought threshold. We see this as a warning the pair’s upside momentum is stretched.
Yet, any market can stay, and become more, overbought (or oversold) for several weeks before running.
Therefore, we maintain our cautious approach to initiating short USD/JPY positioning.
Next Few Days Have High Event Risk
Another reason for caution is US event risk in the coming days.
Tomorrow sees the US jobs report, which could be particularly volatile due to weather- and strike-related factors.
In most months, US employment data is often a trigger for elevated volatility and outsized market moves. This time is especially true given potential distortions in tomorrow’s release.
Following tomorrow’s jobs report, two trading days later is the US election on 5 November.
While betting markets increasingly lean towards a Donald Trump victory, the tight polls are inconclusive and, for many commentators, the race is too-close-to-call.
Then comes the Fed rate decision on 7 November.
Market pricing suggests that a 25bp cut is nailed-on, which is also Dominique Dwor-Frecaut’s base case.
Nonetheless, this Fed meeting coupled with the jobs report and election suggests a week of potentially elevated volatility.
As such, even though we think the next major move for USD/JPY is lower, we are cautious of the upcoming event risk and prefer scaling slowly into a position.