How deep could the greenback retrace from 2-year highs?

The first week of May brought several surprises for the currency exchange market. The greenback’s retracement before the Fed’s decision was predictable as traders took profits, waiting for the FOMC to publish the economic statement and Powell to host the press conference. Regulator’s hawkish comments forced traders to buy the US dollar across the board, and that was logical as well. However, many traders wonder what happened right after the US NFP report? One of the most important fundamental events showed that the US economy is in much better shape than it was previously forecasted. Therefore, currency speculators should have bought the greenback on expectations of higher interest rates differentials and more lucrative investments in dollar-nominated assets. Besides, US stock indices jumped on strong employment figures, but traders ignored that and sold the world’s reserve currency.

Some of the analysts were trying to find a proper explanation for that plunge in the weak ISM Manufacturing Index. Let’s be honest, the importance of that report cannot be compared to the weight of NFP for the Federal Reserve in the decision-making process. Others mention Trump’s pressure on Powell to cut the interest rates. US President forced other White House officials to use verbal interventions. However, central banks’ independence is one of the essential conditions for the modern global economy, and Powell did not agree with politicians, underlining the need for a potential rate hike but not cut. Nonetheless, investors sold the greenback.

Another fundamental divergence is in play for USD/JPY, which is an indicator of the risk appetite. As long as US equities keep posting new all-time highs, dollar-yen should have kept soaring to 113.50 and 114.00 levels in extension. However, the pair plunged to 111.00 support. The interest rates differential is enormous between the United States and Japan. That would attract borrowing capital to flow from low-yields country to high-yields investments such as US stock indices. That double divergence can be explained by only one factor - profit-taking. The thing is that long-term traders were liquidating positions after the US dollar index reached 2-year peak, exiting the market and waiting for a deeper bounce to re-enter with better prices. Such an accumulation of bullish momentum might take another week or two until buyers will come back to the market.

The Bank of Japan did not give any background for the yen to strengthen. The regulator is extremely dovish on the local economy; exporters suffer from trade balance widening the positive surplus, machinery orders and industrial production declined recently. That environment forced BoJ officials talking about further softening of the financial conditions with more stimulus to be implemented in the third largest world’s economy. Japan’s interest rates are already negative at the moment and additional liquidity pumped into the financial system will just weigh on Japanese yen to weaken further.

Technically speaking, USD/JPY is still in a retracement mode. Long-term Ichimoku Cloud trend indicator is bullish on the weekly chart as the span is in the positive territory. The pair had entered into uncertainty zone, testing Ichimoku’s Conversion Line as the first defensive barrier. However, the bears still have enough power to push the pair to the bottom of the cloud, 109.60 yens per dollar. That depth would be extremely attractive for long-term positioning in the scope of call options for this year. The weekly chart below illustrates those assumptions.

The daily timeframe (see the chart below) is bullish as well. USD/JPY breached Ichimoku’s Base Line Support, increasing chances for a test of the upper span’s range. Another crucial support is the trendline (blue), which used to hold prices two times this year (January 31 and March 22). In both cases, the pair used to bounce off the support, reversing the trend’s direction. With that in mind, and taking into the account the fundamental divergence described above, we’d consider the price range of 110.31/110.79 as an attractive level to start buying call options for a long-term perspective. A worst-case scenario suggests more volume added if USD/JPY continued sliding towards the weekly support of 109.60, which is not far from the initial entry point.