Dollar-Yen Pair Has Broken its Moorings and Is Aiming Higher, Strategist Says

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- USD/JPY rate clears key level amid resilience in the USD. 

- Market expectations for interest rates point USD at 114.0

- But analysts are divided in outlook for USD and the JPY.

- Societe Generale a seller and Bank of America is a buyer.

The Dollar was higher against all its major rivals Friday and has now risen above a key level against the Japanese Yen, which could be suggestive of further gains ahead although the strategy teams of at least two major banks are divided in their outlooks for the USD/JPY exchange rate. 

Japan's Yen has cratered in recent weeks and investors are continued to abandon the safe-haven currency Friday amid building expectations of a deal to end the U.S.-China trade war, although the Dollar has long since stabilised and is now on the offensive once again. 

"Overnight, the only equity index which is higher is the Nikkei, which benefited from USD/JPY breaking its moorings," says Kit Juckes, chief FX strategist at Societe Generale. "US yields broke to the upside amid optimism about US and global growth, and yen bears got hurt. We like buying this dip in treasuries, and we like selling into USD/JPY rallies like this one." 

Above: USD/JPY rate shown at daily intervals.

The Dollar still has a bond yield advantage over almost all its major rivals, certainly the Yen, even in spite of three interest rate cuts from the Federal Reserve (Fed). But the prospect of an end to the trade war is soothing the U.S. economic outlook and entrenching the rate advantage for the time being becuase there's uncertainty over if, and how soon, an economic pick up will reach other shores if the tariff fight is called off. 

USD/JPY is one of the most sensitive Dollar pairs when it comes to interest rates and expectations for global growth because Japan is a large provider of capital to the rest of the world. The country runs surpluses on both the trade as well as current accounts, rather than deficits like the U.S. and UK, but interest rates are about as low as they can get and growth has been weak for decades in the world's third largest economy. That tends to see the Japanese looking overseas for places to invest. 

Juckes flagged on Friday the 'spread of 2y2y minus 2yr rates', which reflects market expectations for the gap between U.S. and Japanese rates in the years ahead. When plotted on a chart alongside the USD/JPY pair, it points the exchange rate toward the 114.0 level, which has also been tipped as a prospect by technical strategists at Bank of America Merrill Lynch (BAML). But Juckes is a seller of USD/JPY.

Above: USD/JPY rate and 'spread of 2y2y minus 2yr rates'. Source: Societe Generale. Click for larger image.

"The rally underway is challenging the medium term bearish tone to an important brink, the low 110s. A wall of resistances is currently present from 109.29-110.20," says BAML's Paul Ciana. "This is the kind of resistance that should hold more often than not. A disciplined rules based approach would turn to a bullish bias if a weekly close north of this resistance area occurs. This would align with the bullish head and shoulders on the aforementioned daily chart with upside to 112.50 and 114s."

USD/JPY traded above 109.32 on Friday and could return toward the 114.0 area that market expectations of future rate differentials imply it should be trading at, so long as it can hold above 109.32 and, preferably, clear the 110.20 threshold.

That's the view of Bank of America's Ciana, although he has also said that resistance on the charts could prove to be a bridge too far for the Dollar. And a trader at UBS said mid-session on Friday there's a risk of some 'profit-taking' ahead of the weekend, which could push the pair lower and potentially avert a weekly close above Ciana's "109.29-110.20" band. 

"USDJPY has run into some offers. Both ahead of resistance at 109.50 and also after White House adviser Navarro said he US may be willing to postpone Dec 15th tariffs. First support in the pair 109.15 ahead of 108.65. Risk sentiment has been very positive in last few days and hence there is a risk of some profit taking at these levels ahead of the weekend," says UBS' Thomas Laubscher.

Above: USD/JPY at weekly intervals, with technical indicators . Bank of America Merrill Lynch. Click for larger image.

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