The USD/JPY currency pair has been following an 'up the stairs, down the elevator' pattern since the Federal Reserve and Bank of Japan rate decisions in July. Recent interventions or threats of interventions have triggered a rapid sell-off in the pair, as a crowded trade led to a hurried exit. This dynamic is also affecting other markets, particularly AI stocks, as leverage from the carry trade is coming under pressure, potentially leading to unwinding of hedges.
USD/JPY is currently testing a familiar support level at 156.68. This level was a quick swing low in early August and acted as resistance in early September before providing multiple instances of support over the past month. The pair has not closed below this level on a four-hour bar since the September 17th breakout, with bullish support evident from underside wicks.
From a fundamental perspective, the long side of the pair remains favored, with higher inflation and rate expectations in the US compared to Japan. This has kept the pair persistently strong, even against dual interventions in July. However, the recent breakdown, especially amid stock market weakness, is concerning. The carry trade, which involves borrowing cheaply in Japan and investing elsewhere, relies on hedging currency risk, which puts upward pressure on USD/JPY.
Historically, slower US CPI data has triggered sell-offs in the pair due to fears of narrowing rate differentials. Equity weakness, such as seen in July 2024, has also driven USD/JPY sell-offs. Currently, the equity weakness in Asia and US tech stocks may be causing unwinding of hedges from the carry trade, potentially leading to a larger sell-off. While USD/JPY still has a claim to bullish structure, traders should be aware of the potential for a shift in market dynamics.