The major currency pairs have recently been trading very much sideways. When was the last time we’ve seen the formation of higher highs or lower lows on the daily timeframes? Nevertheless, one pair – the USD/JPY, is setting up for a very important technical break which might take place soon, perhaps even during this week.

The price action on this pair has not reflected its interest yield lately. To hold short positions on the USD/JPY is expensive in terms of rollover, or interest. Besides this, the interest rate outlook for the two economies is very divergent. The United States is expected to raise rates soon, while Japan is having problems with low inflation, and is far from raising rates anytime soon. Money follows yield, but not on this pair at the moment. Of course, the gains that investors have made in holding short exposure on this pair have far outweighed the rollover costs over the last couple of months.

Besides the fundamentals that concern the Japanese and American economies, there is another important fundamental factor that could possibly put additional pressure on the USD/JPY. The risks that surround Germany’s Deutsche Bank could easily start to weigh on the USD/JPY if investors catch a scare and risk aversion gets triggered. The Deutsche Bank is Germany’s largest lender, and Germany is the economic powerhouse of Europe, having the largest national economy in Europe. The US Department of Justice is demanding a heavy fine of $14 billion from the Deutsche Bank for misselling mortgage-backed bonds. This would weaken the bank significantly. Although the Deutsche is much smaller than some American banks, it has significant trading relationships with most of the world’s large finance institutions. If the Deutsche went down, this would certainly restrain investor risk appetite, and could trigger risk aversion, or even a flight to safety if contagion gripped the global financial system.

There was a media report on Friday that the Deutsche and the US Department of Justice were close to agreeing on a settlement of $5.4 billion. This has not yet been confirmed, and as long as the Deutsche faces the threat of a large fine of $14 billion, a dark cloud of uncertainty will overshadow the financial markets. Financial uncertainty favors Yen strength, which is what we’re looking for to drive the USD/JPY through the major 100.00 level. Let’s look at a few charts:

USD/JPY Daily Chart

Here see a classic example of a descending triangle pattern. The pair has been forming lower highs, but the swing lows are all on one level. What makes this particular triangle so powerful, is the fact that its base is at a major psychological level – the big 100.00 level. This setup really appeals to the opportunist in me. Here is a chart I shared in an article last week:

USD/JPY Daily Chart

The idea is to wait for the pair to first break through the 100.00 level, followed by a retracement back to this same level, where a short position is to be initiated. This is the conservative approach. A more aggressive approach would be to pre-position yourself for a possible breakout through the support level at 100.00. If you were to open a trade at the current market price (provided that you got the opportunity to do so), you would get in at a level which is about 128 pips higher than 100.00. This would mean more profit, and a tighter stop, but also a lack of confirmation of the breakout. The way I would like to play this, is to use a combination of the two options. Let’s say we split the lot size we’d like to trade into two smaller positions. One to enter before the breakout occurs, and the other one will be placed at the 100.00 level after a breakout through the 100.00 level has been confirmed by a firm close below this level on a daily basis. Ideally, we want to see the price make at least a hundred pip move below the 100.00 level before placing the pending order at 100.00. The reason for this is to avoid being trapped on the wrong side of a false breakout. Look at what happened on the 18th of August:

USD/JPY Daily Chart

Here you can see that we have recently had a daily close below 100.00. This has not been a good opportunity to enter a short trade at all. As you can see, the pair bounced a massive 430 pips just after we had this daily close. So what we need to look for is a convincing push through the 100 level and a firm daily close below it. A mere 10 to 30 pip distance is not what we’re looking for. A 50 to 150 pip distance is more like it. Remember that smart traders don’t normally put their stop losses exactly on support or resistance levels, they give the price action some room for movement. If we do get a break through the 100 level, the price ideally needs to decline to a zone where a great concentration of stop losses lies. When these stop losses get triggered, it will fuel the momentum of the decline. This is the ideal scenario for a short trade.

The last two trading days’ price action have strengthened my bearish bias on the pair. Look at the following chart:

USD/JPY Daily Chart

I like it when I see price action reject off the 20 EMA like Thursday and Friday’s candles did (the two candles in the red ellipse). This adds to the probability of more downward price movement. The long upward wicks indicate that there were sellers who found good value at these levels. It also shows us where we could expect to find resistance in the form of more sellers who have pending orders lying in this area.

Another technical aspect of the USD/JPY we can’t ignore is the fact that we are fast approaching the apex of the descending triangle in which the exchange rate is currently confined. This tells us that the probability of a breakout is increasing daily.

Major economic events this week

The single most important event scheduled for this week is probably the US Nonfarm Payrolls report on Friday at 12:30 GMT. This is traditionally an event with a massive market moving potential.

The other very important event is the RBA (Reserve Bank of Australia) interest rate decision which is on Tuesday at 03:30 GMT. The RBA is not expected to cut rates on Tuesday, but market players will be listening closely to what the new RBA governor Mr. Phillip Lowe will have to say about the economic outlook for Australia, and what we could expect in terms of interest rate adjustments over the near- to medium-term. The strong Australian dollar is a burden to the Australian economy and could be a factor which may necessitate a rate cut by the RBA sometime in the next year.

Tomorrow we have some production numbers out of Japan, Germany, the UK, and the US. Be sure to keep an eye on these releases.

It is a holiday in China this whole week, and tomorrow is a holiday in Germany.

Have a prosperous week!