Why has the USDJPY returned to 105?

A great deal of attention landed on the USDJPY when it reached 110 earlier in the month, but the rally fell short of the next resistance level at 110.270 and the pair pulling all the way back to 105 was expected. Although we predicted this move to happen later in October, the sell-off in the US markets yesterday encouraged the USDJPY pullback to happen earlier. In the early hours of Thursday’s trading, the pair has shown some signs of trying to recover losses by moving as high as 106.320 but no upcoming bull runs in the USDJPY are expected and thus the pair is likely to conclude the month around 105. But why was the pullback expected?

Aside from noticeable improvements in US economic data, the major driver behind the USDJPY bull run was investors pricing in future JPY weakness. This reflected the ongoing detrimental impact the April sales tax is having on the Japanese economy and heightened speculation that the Bank of Japan (BoJ) will need to add even further QE to boost its economy. Comments from advisors to Prime Minister Abe that a weaker JPY was positive for the Japanese economy and even BoJ Governor Kuroda expressing that the central bank is prepared to act if necessary enticed JPY weakness.

Since then, the JPY has strengthened for at least two reasons. The first reason is because further QE has not yet materialized, and if the BoJ do decide to add further stimulus to its economy we are looking at this happening in December at the earliest. Secondly, investor demand for the JPY is heightening due to fears over global economic growth. Even though there are fears over the robustness of Japan’s economy investors – particularly Asian investors - remain attracted to the Yen as a safe-haven. China’s latest GDP is going to be announced next Monday and there are fears the data will be considerably below Beijing’s 7.5% target which will likely fuel more interest in safe haven investments such as the Yen.

UK forecasters, Now-Casting Economics, estimate that China’s GDP will be announced at a 6.8%. If this proves to be accurate, the movement on the stock markets should be intense and I would expect demand for the JPY to intensify. As such, the USDJPY will come under pressure.

Contrary to appearances, the Greenback softness is not yet related to fears over an economic slowdown in the United States. Instead, it is correlated with a refusal from the Federal Reserve to indicate the timeframe to expect a US rate rise. The Fed’s lack of clarity on the time of a rate rise was expected, and although the Fed concluding QE in less than a fortnight should be seen as a vital indication that the Federal Reserve are moving towards normalizing monetary policy, Janet Yellen and fellow members of the FOMC never were, and never will be hurried into raising interest rates.

Although I am in agreement that the progress the US economy has made over the summer months has been impressive, we must all remember that the US economic recovery has at times been under pressure. QE in itself has taken three rounds and one member of the Federal Reserve, John Williams yesterday indicated that a fourth round might even be a possibility if the global economic outlook changes significantly and inflation shows little signs of returning to the 2% target. After the Federal Reserve concludes QE at the end of October, they will be analyzing economic data very carefully for the remainder of the year.

If no aftershocks following QE’s conclusion are experienced, then we can expect talks about a rate rise to elevate. We are expecting a timeframe hint to be offered from the Federal Reserve around January/February. The markets are currently getting slightly over excited regarding the possibility of rate hikes sooner that the middle of 2015. In the meantime, analysts are keeping a close eye on the reaction of China’s GDP announcement and any potential shockwaves this could create on both stocks, as well as the currency markets.