AUD/JPY: a strong technical case to be made for a reverse - Scotiabank

Carry trades have done well this year overall, with carry-focused strategies gaining fairly consistently relative to other stylized currency investing techniques.

Key Quotes:

"Terms of trade-driven strategies (the 2015 story) are flat on the year while momentum and value approaches are only modestly positive. A growth-focused FX investing theme has been a bust this year.

Markets are, if anything, cyclical, however; leaders become laggards and vice versa. Given the focus on US growth prospects and the risk that rising US interest rates prompt more volatility and an investment environment that that is less suitable for riskier investment strategies, such as carry trades, 2017 may see something of a reversal in returns from these two approaches."

"We think the JPY sell-off is now looking very stretched and may be prone to a correction. Since 2010 (and even before, excluding the volatility around the financial crisis), AUD/JPY swings higher have been quite regular in the sense that the short-to-medium rate of appreciation in the cross rarely exceeds 10% or so over a three month period. Sell-offs in the cross are also quite regular but usually trough after a fall of nearer 15% over that time frame. JPY crosses tend to climb slowly and correct spectacularly, it seems. The rate of gain since September suggests to us that the cross should stabilize and may, in fact, fall quite sharply in the next few months.

There is a strong technical case to be made for the AUD/JPY cross to reverse. The H2 2016 rally in the AUD broke major trend resistance off the late 2014 high but has stalled right on the 50% Fibonacci retracement of the entire 102.84/72.53 move down seen over the last two years. Weekly price signals suggest a peak and reversal is in the process of forming right at a major resistance point. This is the sort of thing that pique’s our technical interest.

Bearish technical signals for AUDJPY alongside significant over-valuation signals suggest downside risks for the AUD are rising. We suggest selling current spot, risking 88 and targeting a move back down to 75."