FX Update: Can JPY steal some of the USD’s thunder?

FX Trading focus: The USD has broken higher – how far can it extend?

As we discussed in today’s Saxo Market Call podcast, equity markets have entered the danger zone in volatility terms in which only binary outcomes seem possible – either a continued and possibly accelerating sell-off or a huge bounce of equal energy to the prior down move – or first the former followed by the latter. In FX, we have seen an odd “tick-tock” in which first it was only the US dollar that was ascendant on the sharp rise in US yields in the wake of the FOMC meeting, followed by a now more vicious and steep rally in the Japanese yen after USDJPY spiked to new highs, as US yields then calmed as risk deleveraging continued. If the risky asset sell-off extends with treasuries sidelined and even rallying, the JPY may edge out the US dollar as a safe haven, but this would likely prove only a short-term development as long as yields are set to rise further down the line, as is our base case.

But really, we need to see the climax of this risk-off event in the rear view mirror before judging market potential here outside of the general idea that anything can happen: and FX volatility, as I also pointed out in the podcast and in recent comments, is still very low – EURUSD has only just now taken back 5.0% for three-month implied,  and three-month USDJPY implied volatility is still below 6.0%.

Interesting data points are up today, though I’m not sure the market is particularly engaged on data right now. These include the US Aug. PCE Inflation indicator, expected to show a slight drop at the core, but already looking stale as this release isn’t very timely and the big price rises of note have been in September. We also get the Sep. ISM Manufacturing after inconsistent regional numbers. The private Markit survey suggests no cause for concern there. The September headline Euro Zone CPI was out today at 3.4% year-on-year vs. 3.3% expected. With natural gas and power prices at multiples of their prior moving averages before winter even settles over the continent, the inflation levels look set to stay elevated or rise even further in coming months. Next gets more interesting with the latest US jobs report and whether workers whose benefits are expiring are rushing to try to fill one of the record number of job openings.

Chart: USDJPY
USDJPY has reversed fairly hard here, probably as US treasury yields were the chief driver of the original rally sprint to 111.50+ and the pair looked overextended as long US yields eased back and traded sideway, as the focus shifted to deleveraging in risky assets. A total reversal here is note the base case here and would take more downside – falling back below 110.00 – with a coincident erasure of the recent pop higher in US yields at the long end of the curve. Barring a very ugly volatility event – which we by no means can do – the sights are set higher in the medium term, assuming the Fed is set to continue its path towards policy normalization. Still, it is interesting to note that a number of JPY crosses are sucking wind and poking back toward major support levels after this equity market consolidation – including GBPJPY dipping back near the important 148-50-149.00 area and EURJPY now closer to a major support zone around 128.00.