Is the yen’s resurgence about to derail the global market recovery?

Global markets are feeling the pressure as the yen’s recent strength raises fresh concerns, potentially disrupting what looked like a budding recovery. The resurgence of the Japanese currency is casting a shadow over the carry trade unwind, following positive news from the US labor market that had sparked hopes of a market rebound.

European stocks made modest gains, trying to stabilize after a week marked by unprecedented volatility. Across the Atlantic, US equity futures wiped out early gains despite the S&P 500 recording its best daily performance since November 2022. Still, the index is on course for its fourth consecutive weekly decline. Treasury yields also dipped, and the dollar showed signs of weakening.

Blame it on the yen

The yen’s renewed strength is a major concern, threatening to dampen the recent resurgence in risk appetite. This comes just as an encouraging US jobless claims report helped ease recession fears sparked by disappointing employment data last week. Much of the market's direction now hinges on upcoming US data, particularly consumer inflation and retail sales figures, as investors look for signs of a soft landing.

“Market volatility could remain elevated for some time,” warned Mark Haefele, Chief Investment Officer at UBS Global Wealth Management. “The unwinding of yen carry trades could lead investors to pull back from riskier assets, especially with economic uncertainty still looming large.”

Bob Savage, Head of Markets Strategy at BNY Mellon Capital Markets, echoed these concerns. He believes that there is still significant room for more carry trades to unwind, with short-yen positions likely to be further reduced as the Japanese currency continues to strengthen. Savage noted that investors remain overly bearish on the yen, which could continue its advance, potentially reaching 100 per dollar in the future.

On the charts

The Japanese Yen has seen a volatile week, with USD/JPY oscillating around the 147.00 mark as of August 9, 2024. This choppiness comes amid shifting expectations for Bank of Japan (BoJ) monetary policy and broader risk sentiment swings.

Resistance

The pair is currently testing the key psychological level of 147.00. A sustained break above this could open the door for a retest of the recent high at 147.82. Beyond that, the Tenkan-Sen at 148.45 and the 150.00 handle pose significant hurdles.

Support 

On the downside, immediate support lies at 146.00, followed by the August 6th high of 146.37. A decisive break below this zone could trigger a deeper pullback towards the 145.00 level and the August 6th low of 143.61.  

Fundamental Drivers

BoJ Policy Outlook

The BoJ recently surprised markets with a modest rate hike and hints of future policy normalization. However, subsequent dovish comments from BoJ officials have tempered expectations for aggressive tightening, weighing on the yen.

Risk Sentiment

Global risk appetite has improved in recent days, leading to a pullback in the US Dollar and a slight rebound in the yen. However, the outlook remains uncertain, with ongoing concerns about the global economic recovery.

US Treasury Yields

US Treasury yields have retreated from their recent highs, further contributing to the US Dollar weakness. The yen is particularly sensitive to movements in US yields due to the carry trade dynamic.

Outlook

The near-term outlook for the yen remains uncertain. While the recent BoJ policy tweaks suggest a gradual shift towards normalization, the central bank is likely to proceed cautiously, limiting the yen's upside potential. Moreover, the evolving global economic landscape and risk sentiment could trigger further volatility in USD/JPY.  

In Japan, the Topix index managed to close 0.9% higher, though it had been up as much as 2% earlier in the session. The gains narrowed as the yen reversed its losses, strengthening against the dollar. This currency strength poses a challenge for Japanese stocks, as it reduces the competitiveness of Japan’s exports.

Blame it on the weather

Meanwhile, Chinese stocks flattened after an initial rise, with many attributing the better-than-expected inflation data to temporary factors such as weather conditions. That’s right… the weather.

Adding to the uncertainty, mixed signals from the US Federal Reserve are likely to keep investors on their toes. Kansas City Federal Reserve President Jeffrey Schmid expressed reluctance to support rate cuts with inflation still above target, suggesting that monetary easing might not come as quickly as some had hoped.

Swap traders have begun to scale back their expectations for aggressive Fed easing in 2024. The global market repricing has been so intense that, at one point, interest-rate swaps implied a 60% chance of an emergency rate cut by the Fed in the coming week—well ahead of the next scheduled meeting in September. As of now, the market is pricing in about 40 basis points of cuts for September.

Conclusion

The global markets are teetering on the edge as the yen’s strength and the unwinding of carry trades threaten to undermine a fragile recovery. With upcoming US data poised to play a critical role, investors should brace for continued volatility. While some signals suggest resilience, it’s clear that market dynamics remain unpredictable. Traders would do well to stay cautious, as the intersection of global economic factors and currency movements could lead to unexpected twists in the weeks ahead.

Traders should closely monitor the key technical levels mentioned above, as well as any developments related to BoJ policy and global risk appetite. A sustained break above 147.00 could signal further yen weakness, while a decisive move below 146.00 could open the door for a more significant correction.