fed watch risk of carry trade pair audjpy unwinding in the shortmedium tem 1808602016

In the last March 2016 Fed’s FOMC policy meeting, Yellen and company has adopted a dovish stance in the pace of future interest rate hikes as the initial “dot plot” of 4 projected rate hikes in the last December meeting has been reduced to only two hikes for the entire 2016. The next “dot plot” projections will be released only in the 14/15 June 2016 meeting.

Based on the latest Fed Fund futures pricing, market participants have completely ruled out a rate hike in today’s meeting and even expect only one interest rate hike for 2016 (a higher probability of 42%  to occur in the December meeting) versus the Fed’s current projection of two.

All these expectations of a “relaxed tone” of interest rate hikes have favoured risk assets (equities) as they have stage a rally of 16%/20%  from 11/12 February 2016 lows. In the currencies space, the carry trade strategy (long higher yield currency through borrowing in lower/negative yield currency) is also back in vogue due to a reduction of volatility since the February 2016. According to data compiled by Bloomberg, the Deutsche Bank G10 Carry Basket Index has shown that carry trade returns have reached the highest levels last week since 07 December 2015, a risk of an overcrowded trade at least in the short/medium-term.

Today’s Fed meeting will not have a press conference by Yellen and market participants will scrutinising is there any “change of tone” in the confidence of the external environment in the press statement. In the last meeting, the Fed has turned more dovish is largely due to the “shock” caused by the global stock markets and commodities sell-off that may dampen consumer and corporations’ confidence.

Since the last meeting till now, the “external environment” has stabilized with WTI crude oil has recovery sharply and its trading above $40 per barrel and the S&P 500 is now just 2% from its current all-time high. Therefore, the market participants face the risk of under-pricing the pace of future interest rate hikes by pushing it out too far and any change of tone to indicate a slight improvement in the “external environment” is likely to increase the odds of a hike in the June meeting. If this scenario pans out, the USD strength may see a spike up in the short to medium-term and caused the long carry trade strategies to unwind. We take a look at carry trade pair, AUD/JPY from a technical analysis perspective.

AUD/JPY – Short to medium-term potential downside pressure below 85.48/86.40

(Click to enlarge charts)

Key elements

• Since the pre Great Financial Crisis high of 107.87 seen on October 2007, the AUD/JPY has been evolving within a potential long-term “Symmetrical Triangle” range configuration with its key lower boundary (support) at 74.52/72.00 zone which also confluences with the major swing low areas of July 2009,  May/June 2010 and October 2011  and  a Fibonacci cluster (see weekly chart).
• On the medium, the AUD/JPY has been evolving within a bearish descending channel in place since November 2014 high with its upper boundary (resistance) at 86.40 (see weekly chart).
• The advance of 11% from the 77.60 low printed in February 2016 (in line with other risk assets such as equities) has stalled right at the aforementioned descending channel resistance at 86.40 which also confluences with the minor swing high areas of 29 January/14 March/30 March and 22 April 2016, the pull-back resistance of the former ascending trendline from February 2016 low (in dotted red) and the 0.618 Fibonacci projection of the up move from February 2016 low of 77.60  (see 4 hour chart).
• The 4 hour (short-term) RSI oscillator has broken below its former trendline support and it has also flashed a prior bearish divergence signal. In addition, the current reading of the RSI still has room to manoeuvre on the downside before reaching its extreme oversold level. These observations suggest that downside momentum of price action has resurfaced for the pair.
• On the short/medium-term, the key supports to watch are at 82.35 (the minor swing low of 18 April 2016 that has tested the former minor swing high of 08 April 206 + the trendline support that has the higher lows of 11 February and  07 April 2016  follow by 79.80 (multiple congestion of swing lows from 19 February  to 01 March 2016).

Key levels (1 to 3 weeks)

Intermediate resistance: 85.48

Pivot (key resistance): 86.40

Supports: 82.35 & 79.80

Next resistance: 90.52 (long-term)

Conclusion

Technical elements suggest that the AUD/JPY is facing the risk of further downside pressure in the short-to medium-term. Any potential minor rebound in price action is likely to be capped by the intermediate resistance at 85.48 with a maximum limit set at the 86.40 medium-term pivotal resistance before another down leg materialises to target the 82.35 support in the first step. Only a break below 82.35 may open up scope for further downside pressure towards the next support at 79.80.

On the other hand, a clearance above the 86.40 medium-term pivotal resistance is likely to invalidate the expected bearish move for an extension of the rally towards the 90.52 long-term resistance(see weekly chart).

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