Pound-to-Yen Rate Pulls Back From Bearish Precipice

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The Yen's rally versus the Pound has stalled on easing Brexit fears.

The Pound has recovered against the Yen and the pair is currently seen trading at 149.96, after rebounding from the 147.98 lows established during yesterday's sell-off.

The Pound's recovery over the last 24 hours has been due to easing Brexit fears after the EU and UK were seen as getting closer to agreeing on an official transition agreement which would give the UK a 2-year breathing space after Brexit to agree details of the new relationship with the EU.

This had come after a bout of Yen strength after Japan registered the longest run of growth in 28-years.

The Pound-to-Japanese Yen rate is now sitting precariously on an area of tough chart support in the 147-8s, and the question now on most traders minds is will the pair recover?

It's impossible to say for sure but bearish risks remain.

If the pair were to break below the 147.98 lows, for example, that would exacerbate downside and probably lead to a strong move lower.

The next target from such a sell-off would be  141.05, which is calculated using the common technical method of taking the height of the move immediately prior to the trendline break, labeled 'a' and extrapolating it lower after the break in a move of equal distance labeled 'b'.

A close up of the current price action is shown on the chart below. 

This also shows how the MACD momentum indicator is falling in line with the exchange rate and how it has fallen below the zero-line which identifies the trend. This reinforced the bearish tenor of the recent sell-off. 

We are not the only ones who see the possibilities tilted to more downside, Natixis bank is also bearishly biased the pair.

"The risks are on the downside with the increase in the daily volatility and the sell signals on the daily indicators," says analyst Michaella Feldstein of Natixis.

A break below 148.80 would confirm downside reversal, and "pave the way down to support at 146.80 (horizontal trendline) ahead of the 143.55-143.70 area (monthly Bollinger moving average)," says Feldstein.

Yen Rising

The fall in GBP/JPY comes on the back of a general strengthening of the Yen as a result of a change in the way investors view the economy and monetary policy in Japan.

The currency has long been weakened by the ultra-loose monetary policies of the Bank of Japan (BOJ), who have been printing money since their war on deflation began in the 1990s.

Yet investors now see the possibility that the BOJ may stop printing money and raise interest rates instead - a move that would be positive for the Yen.

Higher interest rates tend to attract greater capital inflows from foreign investors drawing by the higher returns on offer. 

Japan's ultra-low interets rates have also made it a favoured funding currency for what is known in finance as the 'carry trade'. 

The carry tarde occurs when investors borrow cheaply to invest in a currency with a higher interest rate, pocketing the difference in interest recieved and paid out as profit.

Because this involves borrowing and selling the Yen the carry trade has a negative impact on the Yen most of the time.

A rise in interest rates, however, would make it less attractive funding currency, reducing its use in the carry trade, and pro0bably strengthening it as a result. 

The change in monetary policy is expected to come as a result of rising global growth lifting growth in Japan as well, so that 'all the boats in the harbour rise as one' as one analyst put it. 

The effect already seems to be happening going be Japan's recent GDP figures which showed eight consecutive quarters of growth in 2017 Q4 - a feat not achieved in Japan in 28 years, according to Deutsche Bank strategist Taisuke Tanaka. 

For Tanaka, it underpins a broadly bearish outlook for USD/JPY despite the fact both the US and Japanese economies are showing "sustained growth", a state of affairs which would normally result in minimal volatility.

Yet in this case, the two economies are at very different points on the monetary policy cycle, with Japan only just beginning to exit the final stages of its loose stance and the US now well into its tightening phase.

'Loose' in this sense means liberal and infers lower interest rates and other non-standard measures such as QE (aka 'money printing') as well the more esoteric yield curve targeting.

'Tight' on the other hand suggests a type of policy in which the central bank is raising interest rates to deal with an overheating economy reflected in rapidly rising inflation.

The lessons of history indicate that the part of the cycle which has the most impact on the currency is the beginning - for example, remember the 'taper tantrum' when the US Dollar rallied on expectations of an imminent reduction in QE?

The same can be said of the Dollar's surge in late 2016, when the Federal Reserve was about to start raising interest rates for the first time in months, although, the link is somewhat complicated by the impact of Trump's fiscally generous policy rhetoric which also purportedly pushed the greenback higher at the same time.

March-End Effect

In a fairly technical analysis of the USD/JPY pair Tanaka suggests there is a lack of buying support below the 110.00 level which could make the pair vulnerable to deeper declines down to the lower 100s.

"Japanese pension funds, life insurers, and other institutional investors have thus far bought on dips from around 110 and below, but this buying has been far from aggressive and has acted as only a limited support. Overseas speculators still maintain relatively large USD/JPY long positions, and look unlikely to increase them in the near term in line with rising US rates."

The approach of March-end results will probably benefit the Yen, according to the strategist, as companies will want to reduce risk ahead of the event and this will involve the unwinding of carry trades funded in the cheap-to-borrow Yen, which will subsequently rise from the repatriation of those funds from abroad.

Thus March-end results will act like a sort of 'high risk' event and lead to Yen backflows which will be supportive for the currency.

Overall, however, Tanaka is not long-term bearish USD/JPY as he sees the strength of the US economy offsetting Yen gains, yet quite how the Yen will fair against less powerful counterparts, or the Pound, is difficult to assess.

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