Whenever a profitable opportunity appears, traders jump on the money train without delay. This arrival is a big one that has the whole world excited. Last week saw Asian stocks fall into official bear market territory. The broadest index for the region, the MSCI Asia-Pacific has registered a massive 23% fall from its January highs; Japan's Nikkei has slumped a shocking 13% in the month of October alone, and the People's Bank of China (Pboc) recently had to step in 5-days in a row to stop the leak in Chinese equities. One analyst warned that the losses could be a harbinger of a wholesale “capitulation”. So just how will this develop over the coming days and weeks and what will traders be doing to take advantage?
What to expect in Q4
From a forex perspective, USDJPY is probably the most sensitive to the worsening situation in the current equity markets. The pair has lost ground since peaking at the start of October in line with the losses in Japan and the US stock indices.
Analysts eye further losses for the pair in Q4, earning USDJPY the title of the 'next big short'. If there is any way to play the global stock market slump, it may well be to short the dollar-yen, but is that the only option?
The latest sell-off in Asia had its roots in a sudden swift decline in normally 'untouchable' US tech stocks during the previous US session. The Nasdaq tech index had its worst day since 2011 on Wednesday, October 24. The route then appeared to rotate seamlessly into Asia.
The reasons given for the US decline were, “weak US housing data, mixed corporate earnings results, trade war fears and concerns regarding a slowing global economy all contributed to the sell-off,” according to Sydney-based Rivkin Securities.
The US-China trade war was cited as the main catalyst for the Asia-Pacific drawdown. The imposition of trade tariffs on Chinese goods hurts China and its neighbours, including Japan, Korea, Australia and New Zealand. USDJPY has mirrored the decline in the US and Chinese stock markets in October, falling from a peak of 114.55 to a current level of 111.83.
For savvy traders, the yen is often the classic 'safe-haven' and go-to earner, so it always tends to strengthen in times of crisis. It is also negatively correlated to the Nikkei. Thinking about buying yen before it’s too late?
Will Japanese investors turn their back on USD?
The US dollar, on the other hand, appears to have lost its safe-haven status and is now paralleling the US stock market's recent decline. This is probably due to flows no longer entering the US from emerging markets, as was the case during the Turkey crisis in the summer.
USDJPY is also specifically affected by idiosyncratic factors. Japanese investors account for a large proportion of foreign investors in US financial assets. Historically they have favoured 'safe' US treasury bonds (UST) but recently they have rotated into the US stocks. When US stocks decline, therefore, there is a greater backflow from US stocks back into the yen, as Japanese investors pull-out and repatriate their money.
Japanese investor preferences are unlikely to change soon because of the high cost of hedging US debt. This has led to a dramatic fall in demand for USTs, according to a recent report by Bloomberg News. The high cost of hedging means hedged US debt now offers a lower return than Spanish government debt, for example. This is despite higher interest rates in the US. The anomaly is due to higher short-term rates, which are a key determinant of hedging costs.
USDJPY is also showing technical vulnerabilities which make it an attractive 'short' prospect — if not quite the 'next big short'. The pair has just pierced below a trendline drawn from the March lows with bearish implications for future price action.
When prices break a trendline (red line), it often forecasts a continuation of equal distance ('b') that makes for a great indicator when setting take profit ('a') and stop loss. In the example above, the fall is expected to continue, making "sell" the order of the day with a take profit at around 109.25.
An extremely high number of bearish bets in the futures markets also favours yen strengthening and the dollar weakening, supporting the USDJPY bearish view. An extreme of bearish bets is actually a contrarian signal that the yen is likely to rise. When positioning makes a deep trough and then starts to rise as has happened with the yen, it provides an even more reliable bullish signal.
FX News will continue to keep a finger on the USDJPY pulse and inform all Exness traders of coming trading advantages as they break. If you’re ready to board the trading train and use market analysis to influence your trades, sign up with Exness today and be ready for the next hot topic.
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