The opinions expressed in this report are those of Inspirante Trading Solutions Pte Ltd (“ITS”) and are considered market commentary. They are not intended to act as investment recommendations. Full disclaimers are available at the end of this report.
In the August 2 report, Inspirante Trading Solutions explores the divergence in major central banks’ monetary policies, and how such divergence could potentially bring heightened volatility to the FX markets, from fundamental and technical standpoints.
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A Yen for change
Upcoming economic events (Singapore Local Time):
U.S. ISM Services PMI (Jul)
U.S. Nonfarm Payrolls (Jul)
China CPI (Jul)
U.S. CPI (Jul)
U.S. Michigan Consumer Sentiment Index (Jul)
U.S. Retail Sales (Jul)
Investors will focus on the inflation and employment data in the next two weeks to gauge the current state of the economy.
Markets in focus
Figure 1 U.S. Dollar Index (DXY)
The U.S. dollar’s recent break of the 100 mark turned out to be short lived, as it promptly bounced above the support and back into the descending triangle.
Figure 2 DXY (Monthly)
When observed over an extended timeframe, the U.S. dollar displays significant cyclical behavior, with most pivotal turning points occurring at approximately three and a half year intervals.
Figure 3 CHF/USD Futures (Monthly)
CHF/USD has broken out from a 10-year rectangle pattern. If the breakout is confirmed, it bears significant implications from a technical analysis standpoint.
Figure 4 JPY/USD Futures
The overhead resistance for JPY/USD is somewhere between 0.0072 and 0.0073 (roughly equivalent to 138 to 139 in USD/JPY terms). Breaching this level, the yen has the potential to strengthen further to 126 – 127 against the dollar.
Figure 5 EUR/JPY (Monthly)
EUR/JPY currently sits at the upper resistance of a symmetrical triangle that has been in formation for nearly three decades. A strengthening yen will likely prompt a pullback of this pair towards the midpoint of the range, approximately at the 130 mark.
Our market views
Last week, the expected 25bps rate hike by the Federal Reserve (Fed) seemed to have dominated the news headlines, but the Bank of Japan (BoJ) quietly took the global financial stage with a surprising policy shift. In the U.S., even though Chairman Powell subtly hinted at one more potential hike in September, the market and the Fed Dot Plot seem to concur that the end of this rate hiking cycle is in sight, if not already upon us. The BoJ, usually the most dovish among all major central banks, surprised markets by tweaking its long-standing Yield Curve Control (YCC) policy, hinting at the first steps towards normalization of Japan’s yield curve under the new leadership of Governor Kazuo Ueda.
This divergence in monetary policies across the globe, as nations navigate distinct phases of their economic cycles, makes the foreign exchange market an exciting playing field. As shown in Figure 2 above, the U.S. dollar exhibits a strong cyclicality since the 1990s, with major turning points (usually local bottoms) roughly every three and a half years. From this, we anticipate another low in 2024 as the Fed likely pivots its attention from inflation to potential economic downturns. However, the forex market is fundamentally a relative performance trade between two currencies, which inevitably leads us to the question – against which currency should we compare the dollar?
Considering the recent BoJ meeting, the Japanese yen presents a compelling case. Even though the BoJ kept the benchmark interest rate unchanged, its new, more flexible approach to managing its YCC policy has sparked significant market interest. This shift towards more flexible management of the yield curve might be a subtle indication of the BoJ moving away from its aggressive stimulus program.
It’s worth noting that this newfound flexibility does not equate to an immediate end to the low-interest-rate era in Japan. It’s a shift from a perpetual low-rate environment to a scenario where higher rates are now possible. Easy money will continue for the foreseeable future, but the door is now open to potentially higher rates in Japan. This shift is a crucial change in market dynamics, making the yen less attractive as a historically favored funding currency. Figure 3 provides a sneak peek of the potential impact of a carry trade unwinding in the face of diverging monetary policies. The Swiss franc, another popular funding currency, has arguably made a remarkable breakout from a three-decade range against the dollar, as the Swiss National Bank signals a willingness for further rate hikes.
What’s more? Major yen crosses like EUR/JPY and AUD/JPY teeter on the edge of critical inflection points with multi-decade significance, suggesting yen will likely outperform many other major currencies, not just the U.S. dollar. We believe yen’s strength is still in the nascent stage, making the risk-to-reward proposition of a bullish stance of yen increasingly enticing.
How do we express our views?
We consider expressing our views via the following hypothetical trades1:
Case study 1: long JPY/USD futures
We would consider taking a long position on the JPY/USD futures (6JU3) at the present level of 0.0072, with a stop-loss below 0.00697, which could bring us a hypothetical maximum loss of 0.00023 points. Looking at Figure 4, if JPY starts to strengthen and breaks above 0.0074 level, it has the potential to reach 0.0078, a hypothetical gain of 0.0006 points. A JPY/USD futures contract represents 12,500,000 Japanese yen; each point move is USD 12,500,000.
Case study 2: long CHF/USD futures
We would consider taking a long position on the CHF/USD futures (6SU3) at the present level of 1.157, with a stop-loss below 1.117, which could bring us a hypothetical maximum loss of 0.04 points. Looking at Figure 3, if the breakout is confirmed and the up move continues, CHF/USD has the potential to reach back to 1.27, a hypothetical gain of 0.113 points. A CHF/USD futures contract represents 125,000 Swiss francs; each point move is USD 125,000.
1 Examples cited above are for illustration only and shall not be construed as investment recommendations or advice. They serve as an integral part of a case study to demonstrate fundamental concepts in risk management under given market scenarios. Please refer to full disclaimers at the end of the commentary.
The opinions and statements contained in the commentary on this page do not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs. This content has been produced by Inspirante Trading Solutions Pte Ltd (“ITS”). CME Group has not had any input into the content and neither CME Group nor its affiliates shall be responsible or liable for the same.
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