Sterling, yen and FX politics

Tracking risk appetite across bipolar asset markets

WEDNESDAY JANUARY 23, 2013       11:51:00 GMT

After more than a year’s absence I am starting up my commentaries again. This time I intend to take a more flexible and less structured approach; instead of a single daily posting covering a number of topics, I shall make the postings shorter and on some days may publish several items and on others none at all - all depending on the relevance of the material and the pressure of other commitments. The focus in this commentary will be on sterling and the yen, the two currencies which have attracted a lot of recent coverage from analysts and where the technical picture for GBP/JPY pair itself is useful.

The monthly chart illustrates exactly why there is value in following Ichimoku cloud patterns. Resistance has been confronted exactly where it would have been anticipated from this extended time frame perspective. As annotated on the long term chart the GBP/JPY pair has traded within a fairly narrow channel between 120 and 140 for more than two years and I would expect a narrow trading range to persist (quite likely between 130 and 150 in coming months) as both currencies decline together against the dollar.

Trading USD/JPY from the long side has been one of the easiest and most profitable FX trades over the last few weeks and I would not recommend playing the short side on this pair for anything but short term scalping opportunities. An intermediate term target, that is within 3 to 6 months, suggests that the 100 level is an attractor, although another hurdle arises at 94.50, and both seem almost certain to be tested during the coming months.

As the weekly chart reveals a correction has begun just above the 90 level (again this was clearly signalled on the monthly Ichimoku chart) and there could well be a retracement towards the 86 level which would represent a 38% retracement of the move from the breakout in November up to the most recent intraday high, as well as coinciding with the position of the 200 week EMA.

While writing this I have been watching David Cameron’s speech on the UK’s future relationship with the EU. and the commitment to hold an in/out referendum within five years (subject to quite a lot of conditions - such as whether his party wins the next UK election in 2015 which is certainly far from a done deal). The speech is as much about tactical domestic political issues as it is about future EU treaties. One refreshing aspect of the speech is that by offering a referendum to the UK electorate it goes against the tide of the current malaise embedded within the Brussels mindset, well characterized by the phrase "democratic deficit". The speech will also have long term consequences for sterling as well.

GBP/USD has found strong support around $1.58 ($1.5780 is a key level) and there may well be a bounce back towards a test of the $1.6020 level in coming sessions, but longer term a drift lower towards $1.55 is my expectation. However the better intermediate term FX strategic positionining would be to consider the EUR/GBP relationship. From a techical perspective a feasible target for this pair, again from the perspective of the Ichimoku cloud formation, is around 0.8650 which is the top of the monthly cloud and since we are already half way through this cloud the top points to both a target and point of intermediate term resistance.

In addition, as already alluded to there are two fundamental forces which will act to the advantage of the European currency over its UK counterpart. On the one hand the "safe haven" status of sterling which has prevailed over the last three years during the turmoil within the eurozone is diminishing. Whether or not the tail risk from the euro has been eliminated as Mario Draghi has claimed remains to be seen, but certainly there has been a shot in the arm favoring more risk appetite for European securities. Secondly, Cameron’s initiative with respect to a re-negotiation of the UK’s relationship to the EU may well result in some slippage in inward investment to the UK and could further weaken sterling’s appeal as a strategic holding by global asset allocators. Furthermore some within the BOE, including the current governor, appear to favor a weaker currency for macro-economic reasons and will continue to talk the currency down.

From a big picture perspective, given that the yen is likely to remain under pressure, and that sterling will also be weak especially relative to the euro, one of the most appealing long term trends would be a long euro/short yen positioning with an emphasis on adding to positions on EUR/JPY weakness. A target this year of around 128 - which was last seen in February 2010 is a distinct possibility, and an even more ambitious target could put 138 in play which would suggest that Signor Draghi and other ECB cheerleaders may have shot themselves in the foot with regard to removing tail risk and putting the EZ nations at a disadvantage in the race to lowering exchange rates now being pursued by most other central banks.