USD/JPY Heads for a Short-Term Pullback on Profit-Taking
The USD/JPY rally gained steam on Thursday as the market reacted to the carry trade opportunity between the dollar and yen. It rose to 111, the highest level since June last year.
Carry trade opportunity
Carry trade is one of the most popular trading fundamental trading strategies in the market. It refers to a situation where investors borrow cash in a low interest rate country and invest in a high-yielding country. For years, Japan and the US have been popular carry trade countries.
In the past month, the bond yields in the two countries have created an ideal carry trade situation. In Japan, the Bank of Japan (BOJ) is implementing a yield curve control program, where it is preventing the 10-year government bonds from rising above zero. It does this by buying all outstanding bonds to ensure that the yield does not rise higher.
On the other hand, the US bond yields have been rising in the past few months. This week, the yield on the 10-year and 30-year government bonds has risen to the highest level in more than a year. As a result, the spread between the US 10-year and Japan 10-year bonds has declined to the lowest level in more than a year, as shown below.
The US and Japan 10-year bond spread
In general, analysts believe that the BOJ will maintain its interest rates and yield curve control program at the current level for years. On the other hand, there are signs that the Federal Reserve will either turn hawkish or even hike interest rates earlier than expected. This will widen the spread between the US and Japanese spread and create an ideal carry trade opportunity.
Japan and US economies recovering
On Thursday, the USD/JPY price reacted to the relatively strong manufacturing data from the two countries. Earlier in the day, a survey of businesses by the Bank of Japan showed that they were doing relatively well. For example, the large manufacturers index soared from -10 to 5, which was better than the median estimate of -15. This was the first time in months that the index has been in the positive zone in more than a year.
Meanwhile, the Large Non-Manufacturers Index improved from -5 to -1 while the Small Manufacturers Index rose from -27 to -13. Further data by Markit and au Jibun revealed that the country’s manufacturing PMI increased from 52.0 to 52.7.
The same trend happened in the United States. Data by the Institute of Supply Management (ISM) showed that the manufacturing PMI increased from 60.8 to 64.7. This happened as the manufacturing employment index rose to 59.6 while the new orders index rose to 68.0. Data by Markit showed that the manufacturing PMI rose to 59.1. This trend will likely continue as the US launches another record $2.3 trillion infrastructure project.
The data came a day before the US Bureau of Labour Statistics (BLS) is set to release the latest US Nonfarm Payroll numbers.
USD/JPY technical outlook
The daily chart shows that the USD/JPY price formed a bullish flag pattern in March. This pattern is usually a bullish sign. Indeed, the price has soared by more than 1% from the upper side of the flag. It is being supported by the short and longer moving averages. It is also along the upper side of the Donchian Channels. The Stochastic oscillator has also moved above the overbought level. Therefore, the pair may experience a short-term pullback in the near term as buyers take profit.