EUR/JPY: Further downside to come on deteriorating fundamentals

• EUR/JPY struggles to catch a bid on German IFO.
• EUR/JPY bleeds out as EZ economy seen vulnerable to worsening coronavirus implications. 
• All eyes will be on the ECB in March and the DXY back towards 100.

EUR/JPY is trading at 120.03 having travelled between a low of 119.90 and a high of 121.07, firmly in the red by -0.86 due to a blood bath in the stock markets.  The coronavirus is the culprit and the spread of contagion fears are gripping investors into a state of fear. Unless we see a sizeable repricing of China-related risk, the situation appears unlikely to change this week and bears can stay in control. 

What has been interesting of late, and still worth monitoring is how the yen has decoupled from the risk-off trade. We have seen most of the flow head into the US dollar, for sound reasoning, yet the yen has been unable to cash in on risk aversion due to the grim domestic outlook - just look at the latest Gross Domestic Growth figures.  In Chart Of The Week, we see a bullish bias painted on the charts following an upside test of the symmetrical triangle and note the lack of volume towards a 138.2% Fibonacci resistance and the 118 handle. The US dollar has taken a hit at the start of this week, but whether the downside is sustainable is another question – it is still the cleanest shirt in the dirty laundry basket. USD net longs pushed higher for a fourth consecutive week following on from the move in the spot market, and it will not take much for a revisit to the upside once the speculative and less committed longs have been stopped out of spot FX. The greenback is a practical store of value for many investors and US growth data this year have been better than that of many other G10 countries.

EUR to take a knock on dovish ECB in March

By contrast, both the EUR and JPY's grim domestic outlooks should keep them on the backfoot. Traditionally, the yen has been an attractive carry trade and should the coronavirus threat in Asia subside and Japan avoid an outbreak, its attractiveness at a time when repatriation flows kick in with the seasonality factor, the yen could pull in a bid over the euro, especially should we see net EUR short positions to continue to increase.  However, JPY may face more troubles on Thursday, when industrial production data for January may show a worse-than-expected slump, which would add to the negatives in terms of the economic outlook for the country.

Meanwhile, EUR shorts for four consecutive weeks have been increasing which is counter to the trend established at the start of the year, so there are no extremes there yet, which gives more room to go. The economic outlook for the eurozone is dire and there is little room for the European Central Bank to go. Hopes that the German economy had turned a corner were dashed by a slew of bad data (bar today IFO readings, a pleasant surprise, albeit did little so support the currency vs the yen), yet the authorities are still reluctant to come to the rescue and add fiscal stimulus. With the coronavirus outbreak on their doorstep, (Italy's confirmed cases surging in a borderless EU bloc), the lack of monetary policy space means the ECB will be constrained when reacting to any downturn in economic growth.

Other key releases this week will be inflation numbers for eurozone countries. We have the March ECB meeting coming up and CPI will b a major focus, likely to stir up a dovish bias and lean heavily on the euro's attempt of correction against the US dollar – a likely catalyst for DXY heading back the 100 handle. The euros funding characteristics prevent it from taking full advantage of rebounding risk sentiment which may mean there is further downside in EUR/JPY once markets buy back the yen. 

EUR/JPY levels