In 2013, forex trading was linked intimately to expectations regarding changes in the Federal Reserve’s quantitative easing policy. Certainly, in 2014 market expectations will continue to focus on the future of tapering policy. While the era of exceptional stimulus may be at an end, or at least nearing its end, here are three general outcomes for tapering policy that will shape market moves.
First, better economic data may cause the acceleration of tapering to offset inflation headwinds. On the other hand, worse economic data, evidencing a slowdown in the recovery, may cause a suspension of tapering, or even invite renewed aggressive monetary accommodation. The third path is the current consensus, wherein the Fed will proceed with a consistent $10 billion reduction in its bond purchases and systematically wind down QE3 without any sudden moves or expectation disruptions. In any case, what we know is that key economic data releases in the coming year will impact price action in underlying markets. We also know that central bank decisions on monetary policy in 2014 will remain the critical factor in shaping currency prices. The Japanese yen, in particular, has a great sensitivity to inflation expectations.
The yen’s behavior against the dollar has proven to be a reliable surrogate measure of market risk-appetite, or risk-aversion. In 2013 the bullish market sentiment for U.S. equities, driven by QE3, made it attractive to sell yen vs. dollars. If U.S. markets continue to be bullish, USD/JPY price action will likely remain in sync with S&P direction. Buying the USD/JPY will be a logical response to this condition.
In 2014, however, the Bank of Japan (BoJ) is likely to remain aggressive in its commitment to inflate the Japanese economy to the 2% target. Most recent evidence confirms that its policy is working. The Japanese inflation rate was recorded to be 1.61% in November 2013 (see “Japanese inflation rate,” right). This is a five-year high and is a phenomenal surge in inflation from the January 2013 levels of –0.7%. The BoJ is more than half-way to its target. The rise of USD/JPY during this same period is not a coincidence. In 2014 traders will be wise to focus on Japanese inflation data. They can use this factor as an indicator that the USD/JPY likely will be much weaker with 2% inflation than at the current level. How much weaker is hard to say because surely the current price reflects a modicum of expectations that the BoJ will reach its targets. But how fast it gets there is a guess. A disruptive factor may be the increase in the sales tax from 5% to 8% in April. Such an increase has a negative impact on growth — but it actually may be the spark for further BoJ monetary accommodation to offset this impact. Traders should keep track of what BoJ Governor Haruhiko Kuroda has to say as the year unfolds.
Beyond the fundamental force of inflation, an interesting bullish technical pattern in the currency pair is developing. USD/JPY is currently (Jan. 7, 2014) probing the 61.8% Fibonacci retracement level (105.58) of the move from the June 2007 high of 124.15 to the October 2011 low of 75.57 (see “Yen nears key level,” right). It has taken seven years to reach this critical point and a break-out of this key level presents a rare confluence of technical and fundamental conditions. The inflation scenario in Japan translates to the strategy of buying USD/JPY after any significant sell-off and if the 61.8% Fibonacci level is breached, don’t be surprised if the USD/JPY tests the 2008 high just above 110.
Abe Cofnas is author of Sentiment Indicators and Trading Binary Options: Strategies and Tactics (Bloomberg Press). He is editor of binarydimensions.com newsletter and can be reached at firstname.lastname@example.org.