Upside Potential For The Japanese Yen Is Limited

Fundamentals

The Japanese Yen finds itself unable to gain any sort of upward traction against the major currencies, as the stock market rally has diminished safe haven demand. Japanese policymakers could not be happier. The strong currency has hurt the economy in Japan by quashing export demand at a time when the global economy is already fragile. The BOJ has taken steps to discourage domestic investors from repatriating funds back into Yen by aggressively purchasing government debt, forcing investors to look for higher yielding assets.

The Fed is expected to aggressively pursue monetary expansion by stepping up the purchases of toxic debt. This could benefit the battered Euro, Pound and Australian Dollar, as well as emerging market currencies, at the expense of the US Dollar and the Yen. Overall, it looks as though trader sentiment has shifted toward risk taking recently, as evidenced by the recent upswing in equity prices and lackluster price action in government bond trading. Whether or not the shift toward riskier, higher yielding assets will continue remains to be seen.

The stock market could very well be seeing a “dead cat bounce” driven by short-covering and bottom-picking by smaller investors. If the rally in equities does indeed fizzle out, the Yen could stand to benefit; but it seems as though the upside potential is limited by the fact that the Japanese government could intervene further to bring down the value of the currency.

Neutral to bearish traders may look to capitalize on the lethargy in the Yen by putting on a bear call credit spread, selling a May Yen 1.07 call and buying a May Yen 1.10 call for a credit of 50 points per spread. This would bring in a credit of $625 per spread, with a maximum risk potential of $3,125. Traders that choose to employ this strategy would be neutral or bearish, but fairly certain the recent downtrend in the Yen will not reverse course.

The more bearish trader may wish to enter a ratio debit spread by buying a June Yen 1.00 put and selling two June Yen 0.96 puts for a total debit of 40 points. The trader risks the initial investment of $500, with a maximum profit potential of $4,000 if the Yen settles at 0.9600 at expiration. The Yen would have to make an explosive move lower for this trade to reach its maximum potential, so the trader may not necessarily be looking for the maximum profit, but rather, wish to reduce the cost of the 1.00 put by selling the two 0.96 puts.

Technicals

Turning to the chart, the Yen sell-off seems to have stagnated above the 1.01 level. The chart bias seems to favor the downside, as the June contract has been unable to push above the 1.0350 level. The 18-day moving average has acted as resistance over the last week or so. If prices are able to close above the average, it may favor a near-term positive bias for the Yen.

Solid closes below 1.01 would signal a downside breakout and continuation of the downtrend. For the trend to signal a reversal, the Yen would likely have to close above the 1.0610 level. Momentum is showing bullish divergence from both price and RSI, suggesting a short term positive bias.

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