RED FLAG - I haven't been trading the Yen and am grateful for it. But I am deeply disappointed with the price action thus far. Over the past few weeks, I have been looking at the market both fundamentally and technically and have come to the conclusion that we could be at risk for a major pullback. Fundamentally, Japanese officials have scaled back accommodative talk, while at the same time, risk markets are looking increasingly vulnerable. China's effort to curb short selling is a major red flag for me, as this makes it clear the market wants to go lower but is being artificially supported. I don't believe the Chinese government will be able to keep this up much longer and the dam will inevitably break, as it should.
FORGOTTEN THEME - Moving on, one of the interesting things about USDJPY right now is the forces that drive this market. On the one hand, you have a Yen that has been trading lower on monetary policy divergence and an expectation for Fed liftoff. This has been the clear driver of price action these past few years. On the other hand, you have a forgotten market driver that could once again creep back in, which is a major liquidation in risk assets. Up until now, this hasn't been a problem as central banks have been propping the global economy at every turn. But now we are at the end of the line. And so, with risk so close to coming off, there is a good chance this will result in some massive Yen inflows given the Yen's role as a funding currency.
THE QUESTION - So now, when we break it all down, we need to ask ourselves what is priced in more. Is the prospect of Fed liftoff priced in more or is the risk for a major capitulation in risk assets priced in more? Clearly the answer to this one is the former. The market has priced in a good deal of Fed liftoff risk and very little equity capitulation risk. In my view, this should translate into Yen strength sooner than later. Technically, it is important to take a couple of steps back and look at the monthly chart here. USDJPY is highly overbought on the monthly chart and is begging for a correction. At a minimum, this type of technical overextension suggests the risk for any meaningful upside from current levels is limited over the medium-term.
SILVER LINING - With all that said, I am disappointed right now. I would have thought USDJPY would have held below 124.50 on a daily close basis, in favour of the onset of a more pronounced correction. But on Wednesday, the market easily broke through 124.50. Oh ya, and let's not forget comments a few weeks back from the BOJ Governor who said he didn't expect to see much more weakness in the Yen. I suppose my frustration has been mitigated by the fact that I have no exposure. But if we see another topside failure, I could very well get involved. I usually like to sell into rallies. However, in this case, I would consider selling on a downside break. Stand by.