Is This Why JPY Is Surging?

There is a known tendency for JPY to appreciate in August. As Citi's FX Technicals group notes, this tendency is particularly strong when the differential between Japanese and US policy rates is less than 2%, and given the current rate gap, JPY is highly likely to rise again this August. USD selling for JPY by Japanese exporters puts larger downward pressure on USD in August than usual, partly since trading is thin because market players are on vacation. However, in recent years the income account surplus has had a larger impact and along with the major Treasury auctions (interest payments and redemptions) there is an appreciable fundamental flow. In addition, the much-watched technicals (considerably more widely followed in Asian FX markets than the US) are not supportive (of either JPY weakness of Nikkei strength) and given the massively crowded trade, for a foreigner who has purchased the Nikkei on a hedged basis (Long Nikkei and Long USD JPY) this trade could become very painful.

 

Via Citi's FX Technicals team,

Counting from the Louvre Accord of 1987 through 2011, there have been 25 Augusts. USDJPY has closed the month lower in 16 of these (64%; Figure 1). Of the 300 months during the same period, the pair has fallen in 149 and risen in 151 – around half each. This demonstrates just how strong the tendency for JPY appreciation in August is. Between 1998 and 2005, the pair fell in August for eight consecutive years.



In addition, since 1987 through 2011 USDJPY has declined in August 82% of the time when the Japan-US policy rate differential has been below 2%. When it has been 2–4%, the pair has declined 67% of the time. This falls to just 45% if the rate differential exceeds 4%, which is lower than the 50% figure for all months. So JPY appreciates most often in August in years where the Japan-US rate differential is less than 4%, and particularly when it is less than 2%.

USD selling for JPY by Japanese exporters puts larger downward pressure on USD in August than usual, partly since trading is thin because market players are on vacation. This is often cited as a reason why the JPY rises in August. However, historically, the trade surplus has not been notably larger in August than other months. Overall, it has generally been smaller in August.



In recent years, Japan’s income account surplus has had a larger impact on the current account balance than the trade surplus.



A quarterly UST auction is held in August, and its interest payments and redemptions are sizeable. Institutional investors such as life insurers and banks hedge the FX exposure of their US bond investments, and usually reinvest funds from redemptions in USTs. So we do not think that UST redemptions would put significant upward pressure on the JPY. However, investors do not generally hedge the FX exposure of interest payments on USTs, and generally exchange almost the whole amount into JPY. Since 1987 through 2011, the income account surplus has averaged JPY 737bn in August, the second highest level after March and over 10% higher than the January-December average. We see this as one driver for JPY appreciation in August.

In addition, the much-watched technicals (considerably more widely followed in Asian FX markets than the US) are not supportive...



USDJPY is below the cloud, whose lower limit had provided support last week. It has now edged up to 98.5.

The conversion and base lines (Pink and Blue) have already formed a death cross

The lagging span (Green dot) is now below the daily candle 26 days ago which is also a bearish signal.

We now have three major selling signals on the chart. In particular, the cloud is expected to turn into a resistance from a support while it will be very thin in the next two weeks.



The weekly chart shows USDJPY coming down below the conversion and base lines (Blue and Pink).

The base line in particular (Blue) functioned as a strong support in June when USDJPY dropped to 93.77.

It has continued to trend up since then, which is read as one of the mid/long-term bullish signals in itself. However, the weekly candle is now coming below it. In addition, the conversion line (Pink) has recently edged down to 97.6 and is starting to form a “dead cross” with the base line for the first time since last October

USDJPY Daily chart taking out support levels



USDJPY continued to hold the 76.4% retracement against the highs and has subsequently taken out the short term support levels at 96.95-97.02.

We are also trading below the trend line support which effectively converged with those supports

Short term support levels at 95.80, 94.98 and 93.77 are in danger of being tested now, particularly as the bearish weekly from 2 weeks ago is still valid…



A return to test good support in the 93.25-93.75 (200 day moving average and the pivot off which the 76.4% pullback formed) now looks likely

A move below those supports could well open up the way for accelerated losses to take USDJPY back below 90.00

The Nikkei is also flashing some warning signs.



After the surge higher into April this year when this index closed at 13,860 it now stands at 13,825.

That is 35 points lower than the April close during which time it has had a 3,500 point range (A range of 100 times the change). The open close ranges of May, June and July have also been very narrow (Widest was June at 126 points)

This reflects a huge level of volatility and indecision at the peak of this move off good trend line resistance

Given the speed of the up move there are not many levels to “hang your hat on” to the downside.

For a foreigner who has purchased the Nikkei on a hedged basis (Long Nikkei and Long USD JPY) this trade could become very painful.