As Nikkei rallies, upward pressure mounts for USD/JPY

In May, we looked at the correlation between the Nikkei and USD/JPY and stated that both assets may have bottomed out and that some significant gains could be on the way. While we were correct about the Nikkei, the USD/JPY has lagged behind and has hardly moved since that time. Nevertheless the currency pair has been climbing higher in recent times and today it is up for an eight consecutive session with a grand total of 90 pips(!) from its low a few weeks ago. The Nikkei meanwhile is up by a good 1,150 index points since I last covered it. It is difficult to pinpoint exactly what has caused this decoupling of the two assets. My view is that the risk-on environment has boosted the appetite for global stocks including those in Japan while the USD/JPY’s underperformance has been partly due to the fact the Bank of Japan has paused expanding its balance sheet as it continues to remain in a “wait and see” mode following the government’s April sales tax hike, thus precluding further falls for the yen. It could also be that foreign investors are taking advantage of the weaker yen to continue purchasing Japanese equities, which until recently looked quite attractive compared to say the US markets. As Japanese stocks are denominated in the yen, investors have therefore been putting upward pressure on demand for the currency. Likewise, Japanese companies repatriating foreign profits have also also helping to boost demand for yen. As a result, the supply and demand forces have established a stable equilibrium for the yen around 102.00 per dollar.

Assuming the two assets will once again rebuild their strong positive relationship soon, we may either see a sharp correction in the Nikkei and continued inactivity in USD/JPY, or a vicious move higher in USD/JPY accompanied with a less robust rally in the Nikkei. With so much economic data due to be released this week (read our weekly outlook guide here) there’s potential for a strong move in at least one of these assets. Let’s look at the two in more detail:

As my colleague Matt Weller highlighted last week, the USD/JPY had been stuck inside a descending triangle pattern. As can be seen from the daily chart, it looks like the bulls have won this battle for the bears were unable to hold price below the critical support range of 100.85/101.15. What’s more, the currency pair has broken above a corrective trend line and this breakout has been confirmed by MACD posting a bullish crossover. Going forward the key resistance levels to watch are 102.25, 103.00 and 104.00. A slightly longer-term bearish trend line comes in somewhere between 102.25 and 102.50. Support is seen around 101.80, which also corresponds with the 50-day SMA, followed by 101.15 and 100.85.

The Nikkei meanwhile has also created a bullish crossover after the index broke out a pennant consolidation pattern to the upside. It has since taken out several resistance levels including the 15500/20 area, which is now likely to turn into support. The next levels to watch on the upside are 15820, 15950 and 16370/5. The first of these three potential resistance areas is the convergence of two Fibonacci levels: the 78.6% retracement of the down move from the January peak with the 161.8% extension of a much-smaller corrective intra-month move. The 15950 mark was previously resistance while 16370/5 was the high achieved in January. Overall, the technical picture for the Nikkei is still looking very strong and as things stand I wouldn’t be surprised if the index not only reaches those targets but breaks above them too.