Bigger Setback Possible for DXY Index, USD/JPY

US Dollar Outlook:

• The US Dollar (via the DXY Index) is teetering along a key support level, its daily 21-EMA (one-month moving average).
• If the DXY Index closes below its daily 21-EMA for the first time since June 7, it may signal a deeper retracement to come.
• The IG Client Sentiment Index suggests that USD/JPY has a bearish bias in the near-term.

Looking Ahead to the Fed

The US Dollar’s (via the DXY Index) jump to fresh yearly highs was short-lived. The June US inflation report led to speculation that the Federal Reserve could raises rates by 100-bps this month, with rates markets pricing in greater than a 50% chance of such a decision. However, commentary from St. Louis Fed President James Bullard and Fed Governor Christopher Waller quickly poured cold water on those hopes. Now, less than one week before the July Fed meeting, rates markets are discounting less than a 15% chance that a 100-bps rate hike is levied.

Coupled with speculation in the Euro around the July European Central Bank rate decision, the pullback in Fed rate hike odds has taken some wind out of the US Dollar’s sails. And with US equity markets rallying, the dynamic that drove USD/JPY rates higher in recent months – a stronger US Dollar being bad for risk – has been thrown into reverse. Now teetering on a key technical level, a deeper setback in the DXY Index can’t be ruled out, which may be good news for US stocks, but would likely spell more difficult in the near-term for USD/JPY rates as well.

DXY PRICE INDEX TECHNICAL ANALYSIS: DailyTimeframe (July 2021 to July 2022) (CHART 1)

On July 11 it was noted “there still exists a magnet for price to reach for a bit higher: 109.14, the 76.4% Fibonacci retracement of the 2001 high/2008 low range.” The DXY Index briefly touched that level, trading as high as 109.29 before reversing lower. The setback over the past week-plus now sees the greenback gauge retesting its daily 21-EMA (one-month moving average), which it hasn’t closed below since June 7. A drop below the daily 21-EMA would suggest a deeper retracement is possible, to at least the June high at 105.79 in the short-term, followed by 103.42 thereafter. On the other hand, a move up the daily 5-EMA would warrant a more bullish near-term outlook, seeking a return to the yearly high at 109.29.

USD/JPY RATE TECHNICAL ANALYSIS: DAILY TIMEFRAME (July 2021 to July 2022) (CHART 2)

With risk appetite improving and energy prices pulling back, USD/JPY rates have experienced a bit of weakness over the past week. The pair never quite reached the equidistant measured move from the late-June/early-July symmetrical triangle range at 139.74, suggesting near-term exhaustion. Today’s candlestick is taking the shape of a bearish outside engulfing bar, hinting at further downside. Momentum is eroding, with the pair below its daily 5- and 8-EMA (although the daily EMA envelope remains in bullish sequential order). Daily MACD has started to decline albeit above its signal line, while daily Slow Stochastics have dropped out of overbought territory. A return to the area between the daily 21-EMA and the June high (136.65/137.00) is possible over the next few days.

IG Client Sentiment Index: USD/JPY RATE Forecast (July 21, 2022) (Chart 3)

USD/JPY: Retail trader data shows 32.23% of traders are net-long with the ratio of traders short to long at 2.10 to 1. The number of traders net-long is 2.43% higher than yesterday and 28.86% higher from last week, while the number of traders net-short is 3.68% lower than yesterday and 9.06% lower from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests USD/JPY prices may continue to rise.

Yet traders are less net-short than yesterday and compared with last week. Recent changes in sentiment warn that the current USD/JPY price trend may soon reverse lower despite the fact traders remain net-short.

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— Written by Christopher Vecchio, CFA, Senior Strategist