- USD/JPY has broken above major price resistance
- We think the price breakout along with our forex positioning data favors strength
- Key risk is sharp equity market turn lower
We have been calling for US Dollar strength against the Euro and other forex counterparts for a number of weeks now, and indeed we believe that this is the start of a large USD/JPY breakout. Why do we believe so and -- just as importantly -- what could derail the USD/JPY surge?
Source: FXCM Trading Station Desktop, Prepared by David Rodriguez
One major reason for Japanese Yen weakness versus its US counterpart has been strength in the Japanese Nikkei 225; the correlation chart below emphasizes the strength of said correlation since the USD/JPY set a major low in 2012.
Data source: Bloomberg
Of course, this correlation is a double-edged sword; a turn lower in global equity markets could just as easily derail the USDJPY break higher.
In fact we saw a preview of said risk overnight as both the Nikkei and USD/JPY tumbled on news of a potential airstrike in the Middle East.
Source: FXCM Trading Station Desktop, Prepared by David Rodriguez
We’ll have to keep an especially close eye on equities going forward, as it’s clear that sharp moves could derail the nascent USDJPY breakout. Yet our proprietary forex crowd sentiment data helps confirm that this may in fact be the start of a larger US Dollar breakout.
Source: FXCM Execution Desk Data
We typically use our Speculative Sentiment Index data as a contrarian indicator to price action. Or in plain English: when everyone’s buying, we look to sell.
Recently our SSI data showed crowds at their most net-long USD/JPY since the start of its impressive reversal in September of last year. That might normally make us bearish as price is likely in a downtrend, but impressively one-sided sentiment likewise warns of a potential turn.
Retail forex long positions in the USD/JPY have fallen by a substantial 40 percent from their recent peak, and that has led our sentiment-based Momentum2 trading system to go in the opposite direction.
We like those positions as long as stocks continue to hold gains, and it will be critical to watch the Nikkei’s next moves going forward.