In the world of currency trading, the Japanese yen is special.
It’s known for huge trending moves that can last months if not years.
It might surprise you to learn this, but Japan is the world’s third largest economy. And behind the U.S. dollar and the euro, it’s also the third most traded currency.
The yen is historically a safe haven. This means that it tends to outperform other currencies when the markets are feeling troubled.
For example, when markets crashed from October 2007 to early 2009, the Japanese yen index (JXY) greatly appreciated in value.
But during the 2022 bear market, the yen slumped instead, selling off by almost 25%.
That’s because as the Fed scrambled to raise interest rates in the fight against inflation, the Bank of Japan did virtually nothing.
As of today, Japan’s interest rates are still in negative territory. That’s in stark contrast to the U.S. where rates are around 5.5%.
Investors had very little reason to hold on to the yen when they could easily earn a much higher yield by holding on to dollars instead. As a result, the yen got crushed.
But that could all be about to change…
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The markets are starting to bet that the Fed is very close to the end of their current rate hiking cycle. If that’s true, and traders think the interest rate differential between the yen and the dollar might shrink, it could send the yen soaring.
Check out this chart of the Invesco Japanese yen ETF (FXY) below to see what I mean.
A parallel channel (blue lines) has contained the sell-off in FXY since March. Parallel channels are one of the most important kinds of chart patterns to be on the lookout for.
When a trending move really gets going, it becomes possible to channel it. A great initial clue that a trend is about to change is when prices break out of the channel.
In the case of the yen, that would mean a break to the upside.
A reversal in the yen is on my radar right now because of the bullish divergences visible in several momentum indicators. Bullish divergence occurs when a market is making new lows – as FXY has been doing – but a momentum indicator starts to trend upwards.
The momentum indicator highlighted on this chart is the Relative Strength Index (RSI). FXY registered a bearish extreme in the RSI on June 29.
You can see how as the market broke to new lows in the middle of August, the RSI hasn’t been able to register a new bearish extreme.
This is a sign that bearish momentum is getting exhausted. And when there are more buyers than sellers of the yen, the trend dynamic should shift, and we should see FXY break out of its channel.
When this finally occurs, be sure to check Market Minute for an update.
My analysis is clear – what’s about to happen with the Japanese yen will make for some of the greatest currency volatility, and trades, of all time.
Have you traded the yen before?
Let us know your thoughts – and any questions you have – at [email protected].