Yen Signals More Pain Ahead for Dollar Bulls

  • Japanese currency has almost halved post-election losses
  • Technical indicators point to further declines for pair

The yen is proving a canary in the coal mine for traders gauging the health of the Trump reflation trade. The latest vital signs suggest dollar bulls better keep bailing.

Since the beginning of the year, the yen has nearly halved its post-election losses and has broken several major resistance levels. This is a signal the currency has momentum. If the dollar drops another leg -- a trading term for a short-term trend -- it could be a sign that the Trump-inspired rally is over.

The sale of Treasuries and the repatriation of funds to Japan has helped drive the around 6 percent slide in the dollar against the yen since the November election. Japanese investors cut their holdings of U.S. sovereign debt by the most in three years in December. The Bank of Japan’s bond buying is also anchoring the country’s yield curve, providing a stable investment for investors in government bonds.

Demand for yen has been driven by weekly foreign bond sales and dollar sellers have capped every major rally, according to traders in Asia. That has pushed dollar-yen through its 50-day moving average, the top of the Ichimoku cloud and key support around 112 yen. Several technical indicators show the next support at 110 yen may break.

The meeting between Japan’s Prime Minister Shinzo Abe and President Donald Trump on Friday may also fuel more dollar weakness. Japan has one of the largest trade gaps with the U.S. that widened to almost $69 billion in December. Last week, the president singled out China, Japan and Germany for devaluing their currencies to gain a trading advantage.

Any mention by Trump that the yen is undervalued, similar to recent comments by administration officials about the euro, could be enough to spark the dollar’s next leg lower.

Technicals

  • The latest dollar slide points to a test of 109.90 yen, the base of the current Ichimoku cloud. A sustained break would trigger a major capitulation for technical traders and may catch fundamental investors who had bet on the stronger dollar since the election.
  • The dollar is testing 111.99 yen, the 38.2 percent Fibonacci retracement from post-election lows to highs. A sustained break opens the path toward 109.93 yen, 50 percent retracement of the pattern.
  • Elliott Wave analysis suggests the dollar may have completed the third wave and is now entering the first wave of a new, lower trend. A close below a minor wave support at 111.60 yen would confirm the move.

Still, a cheaper dollar may make Treasuries more attractive and lead to a reversal of the repatriation flows as we head into the end of the fiscal year, which could lead to the next dollar rally.

NOTE: Vincent Cignarella is an FX strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice.

NOTE: Some information comes from FX traders familiar with the transactions who asked not to be identified because they are not authorized to speak publicly.

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