You can bet that the people at the Federal Reserve have been glued to thier Bloomberg terminals all day with one chart on their screens — USD/JPY.
Today’s fall in the pair is no doubt a frightful one. One day after the FOMC minutes revealed that the Fed regards the dollar decline so far as “orderly”, we’re seeing the first signs of a disorderly decline.
In short, things could get start to get ugly here.
One of the tenants of forex technical analysis is to look at intermarket dynamics. There are correlations; some strong, some weak. One of the better correlations of the past two years has been that when stocks risk, the U.S. dollar makes gains against the yen.
Today, with the S&P 500 up 5 points and near a one-year high, we are seeing the U.S. dollar getting crushed against the yen and everything else. Another tenant of technical analysis is that when correlations start to break down, something is changing. What is changing here? Could it be that we are seeing the beginning of a massive dollar sell-off? It’s starting to feel that way.
But before we get too ahead of ourselves, let’s keep an eye on the calendar. Thursday is U.S. Thanksgiving and that should sap trading volumes. Afterwards we get into a bearish seasonal period for U.S. stocks and any sustained decline should boost the U.S. dollar.
What we want to watch, more than anything, is the same chart they’re watching at the Fed.
USD/JPY four hour
We can see that critical support at 88.00 has broken. We wouldn’t be surprised to see a retest of that level before the weekend but the technical damage is done.
What’s truly scary, however, is not that we’ve broken the support on the four hour chart. It’s that we are very close to support on the long-term charts. The weekly support on the left side of this chart is a 14-year low. A break below here would open up the possibility of a test of the all-time low of 80.
Needless to say, this weekly chart shows that we’re already within a few pips of some very, very critical support.
For traders, remember that support levels like these are rarely broken on the first try. We may see a break and then a retest and overall volatility. Still, the implications don’t look good for the U.S. dollar if 87.12 can’t hold in USD/JPY.
What might happen in the event of a disorderly decline in the U.S. dollar? Here’s what the FOMC said in yesterday’s minutes: “Any tendency for dollar depreciation to intensify or to put significant upward pressure on inflation would bear close watching.”
Such a decline in the U.S. dollar has the potential to create a massive conundrum for the Fed. If inflation rises, they will need to raise interest rates. But can they raise interest rates with the housing and banking sectors so fragile? If they are forced to raise rates, what will that do for the recovery? If they don’t raise rates, what will it do for the dollar?
This is what the Fed is worried about right now. Watch dollar-yen closely and listen to what the Fed says next.