USDJPY Topping Wedge Pattern 4H Chart [Fx Newsletter, Jul 8]

This trade idea was first sent to subscribers of the Free Profitable Forex Newsletter on July 8 2022.

Big shifts in global markets occurred over the past 2-3 weeks. Investors went from fearing persistently high inflation to fearing a global recession, with now growing expectations among economists that difficult times are ahead for the economy. Central bank hawkishness and rate hikes are going to slow growth and likely trigger recession in many regions around the world, with Europe looking the most vulnerable in particular due to the Ukraine war. 

A global recession is likely to eventually stop the central banks’ hawkish plans in their tracks, as inflation is also likely to fall in this case. The markets are now starting to believe that the Fed rate hikes will hurt economic growth enough that it will bring inflation down to 2% over the following months. These shifts in expectations caused big moves in major asset classes in the past 2-3 weeks. Global bond yields fell as inflationary fears receded and commodities sold off big time in anticipation of lower demand. Even crude oil fell sharply, despite being a very tight market amid insufficient supply due to sanctions on Russia.

The yen has already strengthened somewhat as a result of the reversal in yields and commodities, though more so versus other currencies than the currently strong US dollar. But this trend may soon reverse too, should fears of a recession intensify further, which at this point seems like the likely scenario. 

Thus, there is increasing potential for a bearish reversal setup in USDJPY, and below we look at the details on the charts.

Bearish wedge formation in USDJPY

USDJPY charts are reflecting the fundamentals, stuck in a wedge formation since June 20. This is the time when the markets started to shift from fearing inflation getting out of control to fearing a recession as it became clear that the Fed and other central banks would not stop hiking rates until inflation expectations fall toward their 2% target.

Essentially, we can use the wedge formation as a clear indicator of where USDJPY is likely to move and when to enter a trade. For this potential bearish USDJPY setup to be triggered, we look for a breakout below the 135.00 zone. This is where the support line of the wedge pattern stands (see chart). A bearish break of the wedge could open the floodgates to further and steep JPY strength. 

Downside targets are toward the 131.50 - 130.00 area, which would likely be reached under this scenario. If the bearish setup is triggered, the targets should be reached fairly quickly as there is little support down until 131.50. If the bearish momentum accelerates, it could push USDJPY even further lower, potentially below 130.00. A steep sell-off in global stock markets would certainly help the yen to strengthen and would intensify bearish pressures on USDJPY and other JPY pairs.

Trade Plan

Entry:

• Wait for a bearish breakout of the wedge. That is currently roughly around the 135.00 zone. 
• A move below the 134.70 low from July 1 should be enough “confirmation” that such a bearish breakout is true. We can use this as an entry signal.

Stop loss:

• Above the most recent swing high following the bearish breakout. Currently, that is above 136.00, but it could be lower if/once the breakout occurs.

Targets:

• 131.50 - 130.00 area
• Potential for a further move down if bearish momentum is strong. USDJPY toward 125.00 is not hard to imagine if stock markets crash hard, for example.

Other JPY pairs may provide even bigger bearish opportunities

As we recently discussed here, there is potential for massive JPY strengthening if some of the trends from earlier this year (i.e., rising bond yields) reverse even more. Basically, the markets are positioned for a lot of hawkishness from the Fed, ECB and other central banks but none from the Bank of Japan. 

With a recession now becoming more likely, this market positioning will have to adjust, and mainly that would be for less hawkishness from Western central banks. This theme alone should be enough to trigger a bigger reversal in JPY pairs.

On the calendar today, traders will watch the Nonfarm Payrolls report. Consensus forecasts ee 260K jobs created in the last month, and unless there are big surprises, up or down from this number, it’s unlikely that the NFP will have a big impact on the market. The Fed mainly cares about inflation now, and that is what the markets will focus on too. In this regard, next week’s CPI inflation report from the US is likely to be a bigger market driver.

Trade signals from the past weeks

• July 1, 2022 - Short NZDUSD from 0.6175 (open in progress)  

TOTAL P/L in the past week: N/A

TOTAL: +5855 pips profit since October 1, 2018