“Long is the way and hard, that out of Hell leads up to light.” – John Milton, Paradise Lost
Last week, we highlighted a big inverted head-and-shoulders pattern on USD/JPY, and with rates peeking above the 125.00 level on Tuesday, bulls finally thought they had fought their way out of the proverbial “trading hell” and into the light (see USD/JPY: Bulls Revving Up, but Break above 124.50 Needed). As experienced traders have learned, though, what the market giveth, it can also taketh away; USD/JPY reversed sharply to the downside Wednesday, falling from a high of 125.30 all the way down to trade briefly below 124. Now, the question on every USD/JPY traders’ mind is, “Does Wednesday’s reversal mark a significant top, or is it just a setback in the context of the longer-term uptrend?”
From a fundamental perspective, USD/JPY continues to be driven by US monetary-policy expectations, and in that context, Wednesday’s reversal is hardly surprising. The influential head of the Federal Reserve Bank of New York, William Dudley, came out Wednesday with lukewarm comments regarding the Fed’s timeframe for raising interest rates, noting [emphasis mine], “Hopefully, we’re going to make progress in terms of our goals…[a]nd so hopefully, in the near future, we’ll be able to actually begin to raise interest rates. When that is precisely, depends on the data.”
While central bankers are not known for being particularly forthright, Dudley’s comments struck traders as particularly ambiguous, especially after a far more hawkish statement from Atlanta Fed President Lockhart last week. In response to these comments and the ongoing global market volatility stemming from China, the implied probability of a rate hike in September have fallen from 55% on Monday to only 39% as of mid-day Wednesday, according to CME FedWatch.
On a technical basis, the outlook for USD/JPY is similarly ambiguous in the short-term but remains long-term bullish. In the immediate term, Wednesday’s price action is likely to form a large Bearish Engulfing Candle* on the daily chart, hinting at the potential for a continuation lower on Thursday -- and the RSI recently formed a small bearish divergence. That said, the recent trend of higher highs and higher lows remains intact and the major moving averages continue to trend higher, so traders may look to fade any short-term weakness. In terms of specific levels, a break below the late July “left-shoulder” low at 123 would point to a deeper retracement toward 122, whereas a close back above 125 would bring the decade-plus highs at 125.80 or higher back into sight.
Source: FOREX.com