NEWS / Foreign Exchange

FOMC Reevaluation Clears Way for Fresh JPY Longs

Now that many members of the financial market community, traders and media have realized that the FOMC statement was not an abandonment of the tightening bias (in fact Fed was more hawkish on inflation this time around) , the market is having another go at the reaction. The Fed's dovish take on growth and housing was a move into neutrality but not an abandoment of the tightening bias.

The dollar extends gains across the board, in line with our morning piece calling for a decline in EURUSD and GBPUSD to 1.3340 and a 1.9620 respectively. Apart from the post FOMC reevaluation resulting from traders??™ overlooking the Fed??™s continued the inflation vigilance remarks from German think tank IFO urging the ECB refrain from further rate hikes is contributing to the euro??™s pullback. With the 4-hour MACDs suggesting 1.3336??”the 23.6% retracement of the 1.3091-1.3412, this could open the way for 1.33 trend line support. Upside surprise in  tomorrow's existing home sales should agree with bearish 4-hr MACD and call up 1.3275-80.

Expect further declines in GBPUSD amid Wednesday??™s surprisingly dovish minutes from the Bank of England. Sterling bulls barely had the chance to cheer the higher than expected 2.7% CPI before the BOE minutes stood in the way. Expect prolonged cable losses towards 1.9620 to stabilize at.96. This calls for further run-up in EURGBP towards 68 pence followed by 68.30.

Wary of the potential repercussions of renewed accelerating yen strength from the Fed??™s dovish shift, Japanese policymakers are reiterating their willingness to provide policy accommodation. This could be interpreted to mean that BoJ will not raise rates soon, but what we think it really means is that the bank attempts to prevent any destabilizing jump in the currency, that would complicate the central bank??™s path to gradual tightening.

Breaking above the 200-day moving average, USDJPY should encounter resistance at 118.33 high ??“50% retracement of the 121.67-115.09 decline. Subsequent pullback stands at 118.50. Focus turns to tomorrow??™s US existing home sales, which should be more eventful in the event of unexpected weakness and place the Fed's housing downgrade in greater perspective. The prolonged weakness in the yen is seen as a ripe opportunity for new longs, especially as US stocks are expected to begin taking profits upon teh realization of the FOMC inflation vigilance.

Depsite the bounce in yields at the momement, the chart below shows that a continuation of the normalization of the US yield curve should help cap the US dollar. Historically, the yield inversion has been positively correlated with escalating yen shorts against the US dollar as well as the decline in the currency.