Trader focus this week should be on the USD/JPY. This Forex pair is at a crossroads this week because of the Bank of Japan’s monetary policy statement on Friday, January 29. The recent sell-off in the U.S. equity markets helped boost the Japanese yen against the U.S. dollar which is something that the BOJ didn’t want to see. It wants a weaker yen because it boosts exports which helps the economy to grow.
Although the yen weakened at the end of the week, it is still likely the central bank will announce additional stimulus in an attempt to further weaken the currency. The stimulus is likely to come in the form of increased asset purchases by the central bank. The problem is that it still needs the cooperation of equity traders to accomplish this because the Japanese yen is a funding currency.
The flip side of the yen
As a funding currency, the yen tends to move lower when the U.S. stock market rallies and tends to move higher when the stock market breaks. During the rally phase, investors borrow money from Japanese banks because of the attractive low rates. They then sell the yen and buy U.S. dollars in order to buy equities. When stocks sell off, investors use their proceeds to pay back the loans, selling dollars and buying yen in the process.
When stocks sell-off, investors use their proceeds to pay back the loans
Last week, the USD/JPY broke sharply lower when U.S. equity markets sold off. However, there was a huge rally to end the week when stocks posted a massive recovery. This helped formed a potentially bullish closing price reversal bottom on the weekly chart. Additionally, the Forex pair was supported by comments from European Central Bank President Mario Draghi, who hinted at additional stimulus measures in March.
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Technically, the main trend is up according to the weekly swing chart, but momentum has been down for several weeks. Last week’s reversal may be an indication that momentum is shifting back up along with investor sentiment. It will all depend on what the U.S. stock market does this week as well as the BOJ decision.
Based on last week’s close at 118.759, the first level to watch is a downtrending angle at 118.748. Trader reaction to this angle will set the early tone for the market. Overcoming this angle will signal the presence of buyers. This could lead to a test of last week’s high at 118.869. Taking out 118.869 will confirm the closing price reversal bottom. This could fuel a rally into the long-term retracement zone at 119.857 to 120.775.
A failure to overcome 118.748 will signal the presence of sellers. This could drive the market back to 117.965. The weekly chart opens up to the downside under this angle with the next potential targets a short-term 50% level at 117.417 and an uptrending angle at 116.965.
Additional stimulus needed
As traders, we have to decide whether to play for the pullback into the retracement zone and potential support angles at 117.417 to 117.074, or trade the breakout over 118.869.
The direction of the stock market and the BOJ decision will dictate what the USD/JPY is going to do and consequently, what we will do. In simple terms, we are either going to be buying strength or buying a correction. However, we will only be buying if the stock market continues its rally, or if the BOJ decides to implement additional stimulus.