US Dollar Outlook:
- The US Dollar (via the DXY Index) is slowly erasing losses from earlier in the week on the back of weakness in EUR/USD and GBP/USD rates.
- However, USD/JPY rates are pulling back, and a head and shoulders top may be taking shape.
- The IG Client Sentiment Index suggests that USD/JPY has a bullish bias in the near-term.
Fed Hikes Odds Peak, US Yields Steady
The US Dollar (via the DXY Index) is clawing back its losses from earlier in the week, thanks to a reach for safe haven currencies as US equity indices turn sharply lower. And while the US Dollar’s gains are coming mainly via movements in EUR/USD and GBP/USD rates, it’s noteworthy that USD/JPY rates are not following suit.
For much of the past few weeks, US Dollar gains and concurrent US equity indices losses were accompanied by a rally in USD/JPY rates, as Fed rate hike odds and US Treasury yields priced-in a more aggressive Fed rate hike cycle. But now that Fed rate hike odds have seemingly hit a ceiling, markets are behaving more…normal, so to speak. As has been the case historically, weakness in US equity indices are being met by lower US Treasury yields and a weaker USD/JPY – a classic ‘risk-off’ reach for safety.
It thus stands to reason that while the US Dollar may be finding its footing, gains may be further to come by if USD/JPY rates are back to acting in a typical safe haven manner. The DXY Index may no longer be a runaway freight train, whereby all USD-pairs move in the same direction all at the same time.
DXY PRICE INDEX TECHNICAL ANALYSIS: DAILY Timeframe (May 2021 to May 2022) (CHART 1)
The DXY Index has rebounded ahead of its daily 21-EMA (one-month moving average), but technical indicators suggest that the streak of overt bullish momentum has ended. Daily MACD has experienced a bearish crossover (albeit above its signal line) for the first time since April 4 and 5, while daily Slow Stochastics are likewise out of overbought territory for the first time since early-April. It may be the DXY Index retains a ‘buy the dip’ mindset until the DXY Index drops below its daily 21-EMA, which has proved itself as support since early-April, but gains are likely to be constrained if they do continue.
USD/JPY RATE TECHNICAL ANALYSIS: DAILY TIMEFRAME (May 2021 to May 2022) (CHART 2)
USD/JPY rates appear to be carving out a near-term top as bullish momentum has eroded throughout May. After not testing their daily 21-EMA from March 8 until May 12, USD/JPY rates are working on their second close below their one-month moving average this month. Daily MACD continues to decline while above its signal line, and daily Slow Stochastics have moved below their median line. A drop below the monthly low at 127.52 would suggest that a head and shoulders pattern has formed, suggesting a move below 122.00 over the coming weeks.
IG Client Sentiment Index: USD/JPY RATE Forecast (May 18, 2022) (Chart 3)
USD/JPY: Retail trader data shows 24.84% of traders are net-long with the ratio of traders short to long at 3.03 to 1. The number of traders net-long is 10.55% lower than yesterday and 2.08% lower from last week, while the number of traders net-short is 3.99% higher than yesterday and 5.75% 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