USD/JPY Squeezes Higher, Is 110 Next?

Daily FX Market Roundup 05.09.16

It’s a new trading week and the U.S. dollar is the strongest currency. For the past 3 months, the dollar has been beaten down but now the bulls are back in control and have taken USD/JPY above 108. Last week’s jobs report fell short of expectations but the steady 0.3% increase in earnings and the uptick in year over year wage growth gave the market hope that retail sales, due at the end of the week rebounded strongly in April. In a rising dollar environment, an unambiguously negative report was needed to keep the dollar down and the glimmer of hope in wages was enough to convince investors to continue to take profits on their short dollar positions.

Short covering is the primary reason for the strong gains in USD/JPY.
Yen long positions hovered near record highs for most of April and according to the CFTC’s report, Yen bulls pared their holdings for the second week in a row. With everyone from the Bank of Japan Governor to the Finance Minister and Prime Minister of Japan threatening to intervene if FX moves become too rapid, speculators are finding fewer reason to be remain short USD/JPY ahead of the G7 meeting on May 26 and 27. Don’t underestimate the power of short covering. When a currency pair squeezes higher quickly, causing investors to panic and abandon their positions, the rally could be sharp and aggressive particularly when positions are skewed so heavily in the opposite direction. While we believe that USD/JPY is still a sell on rallies, the currency pair could soar to 110 quickly if the 20-day SMA at 108.83 is broken.

All three of the commodity currencies performed poorly today with the New Zealand dollar leading the decline. This weekend’s disappointing Chinese trade numbers impacted both Australia and New Zealand but last week, AUD fell more sharply than NZD and this week the New Zealand dollar is catching up as investors bet that the RBNZ will need to ease again soon. Although China reported a larger than expected trade surplus, the improvement was driven by a staggeringly large decline in imports. China is New Zealand’s second most important trading partner behind Australia and the cutback in demand points to ongoing weakness for the world’s second largest economy. That combined with the recent slowdown in Chinese manufacturing activity highlights the challenges ahead for Australia and New Zealand. Therefore we are looking for another 1 cent move lower or more in both currencies. Australia also reported lower drop in job ads last month. No economic reports were released from New Zealand but credit card spending and China’s inflation numbers are scheduled for this evening.

USD/CAD broke above 1.3000 after early gains in oil prices turned into significant losses but profit taking caused the pair to end the day below this key level. Canadian housing starts increased by a smaller amount, reinforcing the slowdown in Canada’s economy. The wildfires in Canada continue to burn but have apparently reached a turning point thanks to light rain and wind shift. Officials say that production could be brought back online within a week. Traders should watch USD/CAD closely because above 1.3000, there’s no resistance until 1.3200. Like USD/JPY, positions were heavily skewed towards a further decline and the velocity of the pair’s reversal could prompt a more aggressive rally as key levels are broken.

Meanwhile better than expected German factory orders helped euro hold onto its gains.
Of all the major economies, the Eurozone is the region with the most important economic reports scheduled for release this week. The uptick in factory orders signals the potential for stronger industrial production. At the end of the week, first quarter GDP numbers are due and a rebound is anticipated after a soft fourth quarter. May is a generally a terrible month for the euro but after 5 days without a rally, we would not be surprised by a recovery in the currency. The Eurogroup is currently holding talks with Greece on reforms and debt relief – a deal is expected by May 24th but setbacks could hamper gains in the currency.

Five trading days have also past without a rally for GBP/USD. The Bank of England meets on Thursday and the fear is that the recent decline in PMIs will make the central bank more dovish. It’s a tough call because economic data points to a weaker recovery but the uptick in commodity prices increase price pressures and in turn inflation expectations. Aside from the BoE decision, the central bank will also release its Quarterly Inflation Report, which may actually be more market moving for GBP/USD than the monetary policy announcement. Politics matter as well and the virtual tie between Leave and Remain supporters heightens the uncertainty heading into next month’s EU referendum.

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