DXY Breakout Continues; USD/JPY Remains in Triangle

DXY Breakout Continues; USD/JPY Remains in Triangle

US Dollar Outlook:

  • The US Dollar (via the DXY Index) is holding near its highest level since May 2020, mainly on the back of a weaker Euro.
  • Funding stresses are superseding risk aversion flows, helping prop up USD/JPY rates in an environment that would otherwise be favorable for a stronger Japanese Yen.
  • The IG Client Sentiment Indexsuggests that USD/JPY has a bullish bias in the near-term.

Sanctions and Oil

Markets are extremely volatile right now, and for good reason. While price action this morning appeared to more of the same – higher crude oil prices, higher gold prices, a weaker Euro, new lows in stocks – reports over the past 30 minutes have offered some reprieve: Ukraine is no longer seeking ascension to NATO, which was one of Russia’s conditions for ending its siege.

This whiff of not terrible news – signs that an off-ramp to Russia’s invasion of Ukraine may emerge – could bring about a relief recovery that unwinds some of the panic and fear baked into commodities and FX markets. But what’s happening with the US Dollar (via the DXY Index) is a multi-faceted story, beyond the contours of the latest headlines.

There are two main reasons why the US Dollar is faring well, and another safe haven, the Japanese Yen, is not. The DXY Index is largely constituted by the Euro, which represents 57.6% of the overall weighting. The Russian invasion of Ukraine poses a significant threat to the near-term European economic trajectory, and the sanctions levied have created a liquidity crunch that imperils European banks.

Against the backdrop of rising commodity prices – which means inflation will be stickier at elevated levels – it means a wide chasm between central banks has emerged: the Federal Reserve will march forward with several consecutive rate hikes, while the European Central Bank will have to provide stimulus for longer than previously anticipated.

The liquidity crunch is a big part of the story, though, with funding stresses emerging sharply in the past week. Depending upon what measure you use – FRA-OIS or currency basis swaps – we’re seeing the most acute funding stresses in financial markets since the early days of the COVID-19 pandemic. Demand among financial institutions for US Dollars has ratcheted higher, helping propel the DXY Index to its highest level since May 2020.

Why has the Japanese Yen not emerged as a winner in an environment defined by falling US Treasury yields, weaker US equity markets, and surging gold prices? One explanation may be what’s happening with oil prices. Japan imports over 90% of its energy from abroad, and the sharp rise in oil prices will erode Japan’s terms of trade; Japanese importers will now have to convert more Yen into US Dollars to satisfy their energy demand.

DXY PRICE INDEX TECHNICAL ANALYSIS: DAILY Timeframe (March 2020 to March 2022) (CHART 1)

The DXY Index is on sound technical footing, having rallied sharply above its daily 5-, 8-, 13-, and 21-EMA envelope, which is in full bullish sequential order. Daily MACD is rising while above its signal line, and daily Slow Stochastics are holding in overbought territory. Even if the DXY Index experiences a brief pullback from here, the table appears to be set for the greenback to run above 100.00 in the very near-term. This point of view will be reconsidered when the DXY Index drops below its daily 5-EMA, which has held up as support on a closing basis since February 18.

USD/JPY RATE TECHNICAL ANALYSIS: DAILY TIMEFRAME (January 2020 to March 2022) (CHART 2)

US Dollar Forecast: DXY Breakout Continues; USD/JPY Remains in Triangle

DXY Index gains have not translated into a breakout in USD/JPY rates, though the pair has not yielded a downside move either. In a sense, the sideways movement that originated in October has continued. Ultimately, a symmetrical triangle may be forming since late-November, which in context of the preceding move, would look for resolution higher. A breakout above 116.50 is eyed.

IG Client Sentiment Index: USD/JPY RATE Forecast (March 8, 2022) (Chart 3)

US Dollar Forecast: DXY Breakout Continues; USD/JPY Remains in Triangle

USD/JPY: Retail trader data shows 32.95% of traders are net-long with the ratio of traders short to long at 2.03 to 1. The number of traders net-long is 14.44% lower than yesterday and 23.22% lower from last week, while the number of traders net-short is 21.95% higher than yesterday and 12.51% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests USD/JPY prices may continue to rise.

Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger USD/JPY-bullish contrarian trading bias.

— Written by Christopher Vecchio, CFA, Senior Strategist

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Originally Posted on: https://www.dailyfx.com/forex/technical/home/analysis/us_dollar_index/2022/03/08/us-dollar-forecast-dxy-index-breakout-continues-usd-jpy-remains-in-triangle.html
By: Christopher Vecchio, CFA

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