USD/JPY to Face Larger Pullback on Break of Monthly Opening Range

Japanese Yen Talking Points

USD/JPY trades to a fresh weekly low (129.45) as it gives back the advance following the smaller-than-expected slowdown in the US Consumer Price Index (CPI), and the exchange rate may face a further decline over the coming days if it fails to defend the opening range for May.

USD/JPY to Face Larger Pullback on Break of Monthly Opening Range

USD/JPY appears to be tracking the recent weakness in US Treasury yields as it consolidates after clearing the April high (131.25), while the Relative Strength Index (RSI) has diverged with price as the oscillator continues to fall back from overbought territory.

Developments in the RSI warn of a near-term correction in USD/JPY as the indicator fails to push back above 70, but another holding pattern may take shape over the coming days as a bull flag formation materialized during the previous month.

As a result, USD/JPY may face a shallow pullback before staging another attempt to test the April 2002 high (133.82) amid the diverging paths between the Federal Reserve and Bank of Japan (BoJ), and expectations for higher US interest rates may keep the exchange rate afloat as Chairman Jerome Powell and Co. look to normalize monetary policy throughout the year.

Source: CME

In turn, the CME FedWatch Tool reflects a greater than 80% probability for at least a 50bp rate hike at the next interest rate decision on June 15, and recent remarks from New York Fed President John Williams suggests the central bank will continue to adjust policy over the coming months as the permanent voting member on the Federal Open Market Committee (FOMC) pledges to “move expeditiously in bringing the federal funds rate back to more normal levels this year.”

Until then, USD/JPY may consolidate as the RSI shows the bullish momentum abating, but the tilt in retail sentiment looks poised to persist as traders have been net-short the pair since late January.

The IG Client Sentiment report shows only 27.86% of traders are currently net-long USD/JPY, with the ratio of traders short to long standing at 2.59 to 1.

The number of traders net-long is 4.68% lower than yesterday and 14.54% lower from last week, while the number of traders net-short is 2.12% lower than yesterday and 0.27% lower from last week. The decline in net-long position comes as USD/JPY trades to a fresh weekly low (129.45), while the small decline in net-short interest has done little to alleviate the crowding behavior as 31.55% of traders were net-long the pair last week.

With that said, USD/JPY may face a larger pullback over the coming days as the RSI diverges with price, but the exchange rate may continue to exhibit a bullish trend over the coming months with the FOMC on track to implement higher interest rates.

USD/JPY Rate Daily Chart

Source: Trading View

• USD/JPY staged a nine-week rally after breaking out of a bull flag formation, but the rally appears to have stalled ahead of the April 2002 high (133.82) as the appreciation in the exchange rate fails to push the Relative Strength Index (RSI) back above 70.
• The RSI may continue to show the bullish momentum abating as it falls back from overbought territory, with USD/JPY susceptible to a larger pullback as price diverges with the oscillator.
• Failure to hold above the Fibonacci overlap around 129.40 (261.8% expansion) to 130.20 (100% expansion) may lead to a test of the monthly low (128.62), with a break of the opening range for May opening up the 126.20 (78.6% expansion) area.
• Nevertheless, USD/JPY may face a shallow pullback as long as it hold above the overlap around 129.40 (261.8% expansion) to 130.20 (100% expansion), with a break above the monthly high (131.35) may spur another run at the April 2002 high (133.82).

— Written by David Song, Currency Strategist

Follow me on Twitter at @DavidJSong