EUR/JPY - Messy chart, Upside risks as the ECB could be a dud

EUR/JPY cross is up 5% this year-to-date. The common currency has been pretty much treated as a growth currency this year, given the strong economic activity and evidence of peak populism across the Eurozone. Meanwhile, the Japanese Yen has been playing its role of a low yielding risk-off currency to the T.

Compare the EUR/JPY and S&P 500 daily charts… the positive correlation since April clearly indicates the cross has regained its status as a global risk barometer. No wonder, during the times of stress, the EUR/JPY declines, however, the broad based USD sell-off ensures the downside is limited [due to EUR strength]. EUR [despite being treated as a growth currency this year] has been going strong, even during times of stress as risk aversion is seen denting Fed’s reverse QE/policy normalization plans, however, talk of the ECB taper refuses to die down.

When it comes to technicals, the EUR/JPY is a mess.

Daily chart

Observations

• The rising trend line was breached in mid august
• Falling channel was breached on the higher side on august 28
• The cross is now moving in a rising channel
• All major averages - 50-SMA, 100-SMA, 200-SMA are sloping upwards
• The 14-day RSI shows a head and shoulders pattern

Daily chart

• The 4x1 Gann Fan line could offer support around 129.18. A solid rebound from the 4x1 line was seen on Aug 18.

Technical View

• A break below 129.18 [Gann fan line] would add credence to the bearish RSI and open doors for a sell-off to 127.56 [Aug 18 low]. An end of the day close below 127.56 would signal the rally from the April low of 114.85 has ended.
• Bullish Scenario: A rebound from the Gann Fan line, followed by a break above 130.64 [Tuesday’s high] would open up upside towards the rising channel resistance of 132.40.

Markets positioned for the QE Taper in October

The European Central Bank [ECB] does not like a strong Euro… but markets already know this. I discussed here, how the dollar index remained resilient on Friday despite the weak numbers [NFP + wage growth]. The reason for DXY’s resilience was the drop in the EUR/USD. The pair neared 1.20 handle before falling to 1.1850 after wires reported growing discomfort at the ECB regarding the rising Euro.

What it means is that the Euro has not priced-in last Friday’s weak US data. EUR bulls are in no mood to build fresh longs ahead of tomorrow’s ECB event as there is always a risk of Draghi surprising with dovish talk.

However, there is widespread belief that Draghi would simply kick the can down the road by saying that ‘the governing council discussed the QE taper, but no consensus has been reached’. Thursday is “too early” for any concrete details to be announced.

46 of 66 economists in a Reuters poll taken from August 28 to August 31 expect the central bank to announce a change in October. A couple of weeks back, more than half economists were calling for an announcement in September. As of now, only 15 economists expect the taper announcement tomorrow, while 5 economists expect it to come through in December.

Clearly, the expectations of QE taper have been pushed out from September to October. This explains the exhaustion in the EUR/USD pair near 1.20 levels.

Scenarios

The EUR could drop if Draghi pushes out the QE taper to December or further out in Q1 2018, in which case the EUR/JPY could fall to 127.56 [August 18 low].

A lack of clear hint by Draghi would be read as a sign that EUR strength is not an issue and the central bank remains on track to begin the QE taper in October. This would open doors for EUR to price-in last Friday’s weak US data, in which case the EUR/JPY could revisit 131.70 and 132.70 area.