The bond and FX markets are at odds, who will be proved right?
USD/JPY hit a low of 110.58 today, a level last seen on September last year. The pair found some support and bounced back up to 110.84 - where the 27 November low is holding - but is now trading back lower at 110.69. As sellers drive the pair below the 100 and 200-day MA in the last week or so, the bias remains to the downside still.
As the dollar continues to grow weaker, the 110.84 support does not look like it will hold for long. And if that fails, the next level to watch for is the 50.0 retracement level at 109.93. It's a slippery slope for USD/JPY, a continued downward move in such an event could arguably see it head towards the 108+ levels in a jiffy.
But the real issue here is the disconnect in signal between the bond market and the FX market. USD/JPY has been known to trade together with quiet a bit of correlation to US 10-year yields and now we're starting to see things diverge.
Rising yields in the US by right should prompt a stronger USD, but in fact it's quite the opposite this time around. The difference now is that the rise in US yields stems also from the rise in Japanese yields - as the BOJ "tapered" debt purchases, which prompted the market to perceive that as a signal the BOJ may look towards tightening monetary policy sooner than expected. In that respect, there's a case for the JPY to strengthen as well.
But a lot of the recent move has also stemmed for USD weakness.
It will only be a matter of time before the two (USD/JPY and US 10-year yields) start reconnecting again and that's when we'll see who is ultimately right - bond traders or FX traders.
The dollar index is trading at three-year lows and broken below key support levels since Friday. If anything, FX traders have more conviction at this point for the dollar to weaken further; and over the last three weeks, that's not a bad trade at all.
YTD performance of major currencies against the USD
