USD/JPY bouncing, but skepticism remains below 118.60 barrier

Earlier today, my colleague Fawad Razaqzada discussed the Nikkei 225 and whether Japan’s most widely-followed stock market index was forming a double bottom or merely seeing an oversold bounce. While the correlation is not perfect (no intermarket correlation is!) that bourse and many other equity indices are closely correlated with USD/JPY.

Historically, the performance of USDJPY has provided a reliable proxy for global equity markets and risk assets as a whole. This correlation makes sense: when traders are feeling more optimistic (high risk appetite), they tend to buy stocks and sell yen to fund carry trades in higher-yielding currencies, but when they are more pessimistic (risk averse), traders have to rewind these trades by buying back yen and selling equities. Therefore, traders of all stripes are keeping a close eye on USD/JPY, which will likely need to show convincing signs of bouncing back before global stocks and other risk assets can recover.

Looking at the daily chart of USD/JPY does reveal some potential “green shoots” on a technical basis, though those fledgling bullish signs could still wither and die without developing into a meaningful bounce.

First, the good news: after dipping to a fresh 4-month low under 117.00 on Monday, USD/JPY managed to rally nearly 100 pips from the intraday low to finish the day in the mid-117.00s and following a pause over the last 48 hours, buyers are supporting rates above the 118.00 handle. Now, the bad news: the “big” rally we’ve seen so far this week has not even unwound the losses from Thursday and Friday of last week.

For bulls to feel at all confident in a sustained rally in USD/JPY (and by extension, world equities), they need to see the pair break back above the key previous-support-turned-resistance level at 118.60; above that level, a continuation toward key psychological resistance at 120.00 becomes possible.

Given the tepid nature of the rally thus far though, we’re skeptical that the USD/JPY will be able to clear the critical 118.60 barrier. Despite this week’s bounce, the MACD is still showing strong (and growing) bearish momentum, while the RSI indicator has left oversold territory, eliminating the short-term “oversold” rationale for further strength in the pair. If rates do stall out at or below the 118.60 barrier, a move back down toward Monday’s lows (116.70) or the 1-year lows at 116.00 could be next.