The continued downward drift in USD/JPY has been largely a result of benign U.S. bond yields, sluggish U.S. economic growth and a general home bias by Japanese investors. Considering the technical and fundamental outlook ahead, this pattern is unlikely to change any time soon.
USD/JPY is the only dollar-based currency pair to have traded below its medium- and long-term moving averages for over 95% of the time since stocks peaked in 2007. Not even the raging commodity pairs of AUD/USD or NZD/USD have attained that feat, as these had sustained rapid declines during the 2007-08 crises when risk aversion assaulted risk assets and commodity currencies to the benefit of the safer USD and JPY.
"Under the radar" (above) shows the pair remained below its 100-week moving average throughout the financial crisis and beyond (between August 2007 and June 2011), while trading below its 55-week moving average during the same period, with the exception of a mere four weeks. USD/JPY’s inability to rebound above both moving averages has so far lasted 201 weeks as of mid-June. Prior cycles when USD/JPY had spent a similarly extended duration below the 55- and 100-week moving averages were in: October 2005-June 2005 (139 weeks); September 1990-September 1995 (263 weeks); and June 1985-March 1989 (195 weeks). Each of those three cycles ended with U.S. interest rate hikes, more specifically, when the tightening campaign was in its later stages.
So how could USD/JPY make a sustainable recovery above its 55-and 100-week moving averages when there are no prospects for any Fed rate hikes or tightening in sight? Despite the official end of the Federal Reserve’s second quantitative easing program in June, the central bank is expected to continue to reinvest maturing mortgage-backed and Treasury securities with the goal of preventing its balance sheet from shrinking. This is expected to go on for as long as the Fed sees no improvement to its latest growth downgrades and dour outlook on unemployment. And although the Fed hiked its inflation forecasts in April, it maintained inflation would be "transitory." In sum, the Fed has not completely ruled out further easing action, stating it will need to make judgments if additional easing steps are warranted.
The "yen part" of the USD/JPY decline stems from Japan’s role as the world’s biggest lender. Japanese investors chase yields abroad away from paltry domestic interest rates, dragging down their currency during rising confidence times and prompting it higher with repatriation at times of uncertainty. Japan’s private sector is notorious for repatriating its capital because there is a lot of it held abroad. Private estimates cite Japanese investment trusts to have $342 billion in overseas assets, nearly half of which are in the United States (for safety), followed by Australia (for yield) and the Eurozone (diversity to USD). Neither the stealth intervention by the Bank of Japan to sell yen for other currencies in September 2010, nor the coordinated intervention of March 2011 succeeded in stemming the USD/JPY decline. The March intervention triggered a 12% rise in USD/JPY, but this promptly was reversed as post-tsunami rebuilding was financed by a massive repatriation of Japanese investments from abroad. Japanese purchases of foreign securities plunged by over 500% in April to ¥508.7 billion, the lowest level on record since the 30-year data was available.
Trading near 80.40, USD/JPY would have to rise by more than 5% to break above its 55-moving average and sustain the climb in order to break the aforementioned pattern. And with the pair remaining 8%-15% below its 100-week moving average since June 2010, it is unlikely to rise by this required amount considering the U.S. macro and monetary policy outlooks.
Fading the rallies will not be without risk. Additional intervention from Tokyo to rein in the yen this year is highly likely and could well provide a periodic 4%-6% gain toward the 83-84 levels. But rather than being guided by absolute figures, traders ought to use the 55- and 100-week moving averages as the upper bands for each recovery. The only way for USD/JPY to break out of these vital trend measures and hold above them is for the U.S. economy to produce sustainable job growth, sufficient for the Fed to begin selling assets and ultimately signal a rate hike. So far, the outlook suggests the opposite and a return toward 78-75 is the more plausible scenario for the third quarter and remainder of 2011.
Ashraf Laidi is an independent strategist and author of "Currency Trading & Intermarket Analysis." His Intermarket Insight column appears daily on AshrafLaidi.com.