Bullish GBP/JPY as Rates in Focus: Q4 Top Trades

Talking Points:

• This is part of the DailyFX Q4 Top Trades series.
• For my Top Trade for this quarter, I went with bullish GBP/JPY, looking for rates to help the pair break out of a four-month pattern of digestion.
• If you’d like to see all of the Top Trades in this series, the link below will allow you to request a guide that contains all of the Top Trades for the DailyFX Team.

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Towards the end of Q3 something unusual happened: The Fed started talking up a possible rate hike. While the bank had previously used forward guidance to transmit to markets that they were planning on keeping rates pegged to the floor for years to come, a continued rise in inflation in 2021 compelled the bank to upgrade their rate forecast for 2022, with the median expectation at the Fed showing a possible rate hike.

Sure, 25 basis points isn’t much and it might seem like a simple token from the Fed. But – that inflation figure remains fairly high in the US and this could keep the bank on track to kick up rates next year. That may not even matter to markets, with Q1 as a clear illustration of rates markets shuffling in anticipation of the Fed. The yield on the 10 year rose from 91 basis points in early 2021 to 176 basis points by the end of Q1, a clear show of investors trying to get in front of any possible tightening that might happen.

Of course, the delta variant had different plans and the Fed remained passive for the rest of the year, into the September rate decision, that is, when the FOMC upgraded their projections to show that possible rate hike for next year.

My top trade for Q4 is based around the premise that markets may continue to shuffle in anticipation of higher rates, very similar to what was seen in Q1 trade. And if that happens, I expect that the US Dollar might not even be the most attractive venue to focus on for that approach, and instead I want to focus on the Japanese Yen.

The Bank of Japan has been sitting on negative rates since 2016 and there’s no sign of letting up. In Q1, when the rates theme was creating a swell of USD-strength, it was also creating some significant Yen weakness. Rates going higher re-enabled carry trades, and with the Yen being backed by a negative rate regime, the currency can be really attractive for funding carry trades. If that comes back in Q4, in anticipation of higher rates in 2022, the short side of JPY can remain an attractive theme.

For the counterparty: I’m choosing GBP as it appears that there’s potential for a rate hike there as well. At the September Bank of England rate decision, the BoE downgraded growth projections but they also warned of the necessity to control inflation, with markets starting to price-in a rate hike in early 2022.

This can keep the topside of GBP/JPY as attractive, with higher rate potential driving both GBP strength and JPY weakness, similar to what had shown in Q1 of this year, when GBP/JPY gained more than 1300 pips while being driven by very similar forces.

On a technical basis, GBP/JPY just spent Q3 holding support at a big area on the chart, taken from the 23.6% Fibonacci retracement of the 2007-2011 major move. That price is confluent with the 23.6% retracement of the shorter-term bullish move, spanning from the 2020 low up to the 2021 high. A hold of support at the shorter-term Fibonacci retracement indicates resumption potential of the near-term trend, keeping the door open for bullish forecasts in the pair going into the Q4 open.

To learn more about Fibonacci, check out DailyFX Education

GBP/JPY Monthly Price Chart

Chart prepared by James Stanley; GBPJPY on Tradingview

— Written by James Stanley, Senior Strategist for DailyFX.com

Contact and follow James on Twitter: @JStanleyFX