Global Sell-off Takes a Breather – USD/JPY and ADU/JPY in Focus

FX Analysis: USD/JPY, AUD/JPY

Markets show relief after yesterday’s global sell-off
USD/JPY sell-off pauses, but threat of the carry trade unwind remains
AUD/JPY embodies the risk off trade within the FX space

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Markets Show Relief after Yesterday’s Global Sell-off

The effects of yesterday’s global sell-off appear to be easing on Tuesday. Risk gauges like the VIX, the yen and the Swiss franc have seen the selling hold up for the time being. The sharp global sell-off has been influenced by a number of factors but one stands at the heart of it, the carry trade unwind.

With the Fed posturing up for a rate cut and the Bank of Japan normalizing its monetary policy through rate hikes, a drop in USD/JPY always seemed likely. However, the speed of its unravelling has shocked markets. For years investors took advantage of ultra-low interest rates in Japan to borrow yen and then invest that cheap money in higher yielding investments like stocks or even treasuries.

Markets currently price in a 75% chance the Fed will kickstart the cutting cycle with 50 basis point (bps) reduction in September, instead of the usual 25 bps, after to the US unemployment rate rose to 4.3% in July. Such concern, sent the dollar lower and the BoJ surprise hike last month helped to strengthen the yen at the same time. Therefore, the interest rate differential between the two nations will be reduced form both sides, souring long-standing carry trade.

Investors and hedge funds that borrowed in yen, were forced to liquidate other investments in a short space of time to finance the settlement of riskier yen denominated loans/debts. A fast-appreciating yen means it will require more units of foreign currency to purchase yen and settle those yen denominated loans.

USD/JPY Sell-off Pauses, but the Threat of the Carry Trade Unwind Remains

This week Fed members attempted to instill calmness to the market, accepting that the job market has eased but cautions against reading too much into one labour report. The Fed has admitted that the risks of maintaining restrictive monetary policy are more finely balanced. Holding rates at elevated levels hinders economic activity, hiring and employment and so at some stage the fight against inflation can jeopardise the Fed’s employment mandate.

The Fed is expected to announce its first rate cut since the hiking cycle began in 2022 but the discussion now revolves around the number, 25 bps or 50 bps? Markets assign a 75% chance of a 50 bps cut which has amplified the downside move in USD/JPY.

While the RSI remains well within oversold territory, this is a market that has the potential to drop for some time. The unravelling of carry trades is likely to continue as long as the Fed and BoJ remain on their respective policy paths. 140.25 is the next immediate level of support for USD/JPY but it wouldn’t be surprising to see a shorter-term correction given the extend of the multi-week sell-off.

USD/JPY Daily Chart

Source: TradingView, prepared by Richard Snow

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AUD/JPY Embodies the Risk off-Trade within the FX World

AUD/JPY can be viewed as a gauge for risk sentiment. On the one hand, you have the Australian dollar which has exhibited a longer-term correlation with the S&P 500 – which itself, is known as a risk asset. Therefore the Aussie typically rises and falls with swings in positive and negative risk sentiment. On the other hand, the yen is a safe haven currency – benefitting from uncertainty and panic.

The AUD/JPY pair has revealed a sharp decline since reaching its peak in July, coming crashing down at a rapid pace. Both the 50 and 20-day SMAs have been passed on the way down, offering little resistance.

Yesterday’s intra-day spike lower and subsequent pullback suggests we may be in a period of short-term correction with the pair managing to rise at the time of writing. The AUD/JPY lift has been helped by the RBA Governor Michele Bullock stating that a rate cut is not on the agenda in the near term, helping the Aussie gain some traction. Her comments come after positive inflation data which has put prior talk of rate hikes on the backburner.

95.75 is the next level of resistance with support at yesterday’s spike low at 90.15.

AUD/JPY Daily Chart