USD/JPY Susceptible to Larger Correction on Break Below 50-Day SMA

Japanese Yen Talking Points

USD/JPY appears to be tracking the weakness in US Treasury yields as it snaps the opening range for July, and failure to hold above the 50-Day SMA (134.13) may lead to a larger correction if the exchange rate trades below the moving average for the first time since March.

USD/JPY Susceptible to Larger Correction on Break Below 50-Day SMA

USD/JPY trades to a fresh monthly low (134.20) as the US Gross Domestic Product (GDP) report shows an unexpected contraction in the growth rate, and the threat of recession may continue to produce headwinds for the US Dollar as it puts pressure on the Federal Open Market Committee (FOMC) to winddown its hiking cycle.

However, the update to the core Personal Consumption Expenditure (PCE) Price Index, the Fed’s preferred gauge for inflation, may force the FOMC to implement a highly restrictive policy as the reading is expected to hold steady at 4.7% per annum in June, and evidence of sticky inflation may curb the recent decline in USD/JPY as Chairman Jerome Powell acknowledges that “another unusually large increase could be appropriate at our next meeting.”

As a result, USD/JPY may continue to track the positive slope in the 50-Day SMA (134.14) as the Bank of Japan (BoJ) remains reluctant to shift gears, and it remains to be seen if Chairman Powell and Co. will project a steeper path for the Fed Funds rate as the central bank struggles to reduce inflation.

Source: CME

However, the CME FedWatch Tool now reflects a greater than 70% probability for a 50bp rate hike in September as the FOMC appears to be on track to adjust the forward guidance for monetary policy, and speculation for a slower rise in US interest rates may keep USD/JPY under pressure as the central bank aims to achieve a soft landing for the US economy.

Until then, USD/JPY may face a larger correction if it pushes below the 50-Day SMA (134.13) for the first time since March, but the tilt in retail sentiment looks poised to persist as traders have been net-short the pair for most of the year.

The IG Client Sentiment report shows 33.16% of traders are currently net-long USD/JPY, with the ratio of traders short to long standing at 2.02 to 1.

The number of traders net-long is 3.88% lower than yesterday and 8.70% lower from last week, while the number of traders net-short is 9.58% lower than yesterday and 12.47% lower from last week. The decline in net-long position comes as USD/JPY trades to a fresh monthly low (134.20), while the drop in net-short interest has helped to alleviate the crowding behavior as 32.87% of traders were net-long the pair earlier this week.

With that said, USD/JPY may continue to track the positive slope in the 50-Day SMA (134.13) amid the deviating paths between the FOMC and BoJ, but failure to defend the opening range for July may lead to a larger correction in the exchange rate if it pushes below the moving average for the first time since March.

USD/JPY Rate Daily Chart

Source: Trading View

• USD/JPY approaches the 50-Day SMA (134.13) after failing to defend the opening range for July, but the exchange may largely mirror the price action from May if it manages to hold above the moving average.
• Need a move back above the 135.30 (50% expansion) area to bring the 137.40 (61.8% expansion) to 137.80 (316.8% expansion) region back on the radar, with a break above the yearly high (139.39) opening up the September 1998 high (139.91).
• However, failure to hold above the moving average may push USD/JPY towards the Fibonacci overlap around 132.20 (78.6% retracement) to 133.20 (38.2% expansion), with the next area of interest coming in around 130.20 (100% expansion) to 130.60 (23.6% expansion).

— Written by David Song, Currency Strategist

Follow me on Twitter at @DavidJSong