Random Thoughts about the Euro-Yen Currency Pair

Submitted By John Bougearel
Clients have been asking about the Euro/Yen, Wilson from fxoperator.com, has also asked about the currency pairing. Furthermore, Denarii from TradingGoddess.com loves posting currency charts on her blogsite. So, here is a big overview of the Euro-Yen spread.

Personally I Never think much about currency pairs, carry trades, etc. I stick to stock markets, bonds, grains, gold, and energies. Still, my style of financial analysis is versatile. Readers should know that I am first and foremost a market technician. That is my trademark. Secondarily, I am a financial analyst formulating thoughts on structural and cyclical forces exerting their influence on the financial markets.

I am versatile, after mucho anos studying of the financial markets, that is, I could first address structural and cyclical forces of a given market, and secondarily glance at a chart for a visual or I could look at the chart and then take a stab at the forces influencing the chart.

We are mostly visualists, so it is best that I start with the latter. That is my usual preference, except perhaps for stock screening. Ok, then, lets get started, because I have to write a book this weekend and constructing scenarios for the EUR/JPY currency pair should set me back no more than 40 minutes of my weekend.

Monthly observations on the EUR/JPY:

The first thing I noted was that there is a decennial pattern at play. At the end of every decade since 1979, there is a cyclical change in trend of significant magnitude. The trend this decade has been bullish, so investors/traders should be aware that countertrend of a certain magnitude may occur in 2010, 2020 and 2030. (How's that for making this post fairly time insensitive?)
Second thing I noticed was a bullish change in trend on the monthly charts according to "Swing Theory." Those unfamiliar with it should at least be made aware of its basic precept: A trend by definition makes higher highs and lower lows or lower lows and lower highs. In the case of this currency pair, the trend was bearish making lower highs and lower lows until 2000. In the second half of the new decade, in the year 2007 to be precise, that bearish trend in the EUR/JPY was broken. The trend is now said to be neutral with perhaps an upside bias if it makes higher lows. We will look at reasons why this shift in trend has occured in the new millenium a bit later. These are just technical notes
Third, between 2003-2006, this currency pair formed a "Bullish Ascending Triangle" i.e. - a flat top and rising bottom. This currency pair broke out of its ascending triangle price base in 2006, successfully resolving itself in the direction the pattern says it should.
1st tier of support is the ascending triangles bullish flat top around 141-142.
I slapped on a Joseph Kitchen 42 month 3.5 year cycle moving average. Thus far, that is working quite well this decade, not unlike how it performed in the 1980's when there were both significant structural (G5 related and such crap) and cyclical (monetary/inflation/interest rate) shifts occurring.
1st Tier of resistance is 188

Weekly Observations

Structural changes at the Fed took place at the beginning of the new millenium. They abandoned their cyclical policy of normalized short term US interest rate policies in favor of cutting short term rates to 1% or negative real rates. Effectively, the US joined Japan in cutting interest rates to zero. A brief Fed experiment of trying to normalize interest rates in 2005-2006 failed miserably causing all sorts of dislocations in the global monetary system. The Fed is rejoining the BOJ policy of cutting short term rates to negative real rates in 2007-2008 cuz they can't handle higher rates.
At this time the Euro currency was adopted. With the US running a 6%-7% CAD and effectively exporting their currency throughout the world- the dollar quickly lost its status as the worlds' reserve currency. The need for the US trading partners to diversify out of dollars in the new millenium was and is clear.
The only major world currency capable of becoming the world's next reserve currency was the Euro. Why the Euro displaced the US dollar as the world's reserve currency is simple. They do not believe in negative real interest rate policies and the debasing of their currencies as does the US and Japan. They believe in price stability above all else. And precisely how did it happen that they set their monetary policy based upon price stability above all else. Easy, the hyperinflation experienced during the Weimar Republic in the early 1920's. Fascinating study of economic history for those who have time to do so.
The BOJ is committed to raising rates as slowly as possible. They never wish to experience the more than a decade long experience of Deflation.
Juxtaposed, the BOJ is the mirrored opposite of the ECB.
Precisely because the BOJ never wants to experience hyperinflation, they will accommodate, accommodate, accommodate. And because the ECB never wants to see hyperinflation again, they will err on the side of restricting policies of accommodation. On balance, because the monetary policies of these two central banks are so perfectly inversely juxtaposed within this economic environment, this makes for a perfect pairing of being long the Euro, short the Yen.

Technically Speaking on the Weekly

With the structural and cyclical backdrop referenced above, it is no surprise to find the Euro having almost doubled against the Yen since the new millennium began.
The bullish trend that began in 2000, began a two year consolidation between May 03 to May 05. During that phase it formed a bullish triangle that resolved to the upside until July 2007.
The Euro advance against the Yen from Nov 03 and May 05 to July 07 formed a bullish flagpole up to 169. Traders/investors should be acutely aware that the credit crunch of 2007-2008 aborted the intermediate and long term bull trend in this currency pair. How long that trend abortion last is uncertain, but it likely has many months yet to play out.
Flagpoles are supposed to be followed by bull flag patterns. Flag patterns are continuation patterns that typically fly at half mast. This means, when a flagpole consolidates, it should chop around and find support at about the mid-point of the flagpole. In this instance the mid-point is around 146.5.
The initial spike down found support at 149 in August 07 above 146.5. But that spike down was too brief to constitute a fully formed flag pattern. As such, the turbulence that began with the credit crisis in 2007 suggests that we may have several more months of consolidation ahead before the long term and intermediate term trend continues. Remember it took two years of consolidation from May 03 to May 05 before this currency pair began trending again. So, as a general rule, the intermediate outlook could be one of consolidation from July 07 to July 09 - or thereabouts ~ only looking for a rhyme here, not a identical repeat!
Moving average is a 78 bar weekly average, this equates to 6 quarters or 18 months and traders should note it is working wonderfully in the new decade.

Short Term Trend Observations

First, May 05 noted on the weekly chart is actually June 05
Secondly, from June 05 to July 07 a bull flag pole formed
The credit crunch in the second half of 2007 aborted the bull trend, but nevertheless, the trend found support at the 149 Half mast target.
Since finding support at half mast, the pattern appears to have morphed into a bullish contracting triangle.
If the credit crunch significantly worsens, the contracting triangle will morph into a larger consolidation that could take the spread back to the 139-141 targets on the daily and weekly charts. If it doesn't significantly worsen, the contracting triangle pattern will remain in force with initial tier of support around 153-154.
Traders should note the 260 day one year average is not acting as resistance in 2008. Without an improvement on the credit crunch front, sustaining a breach of this average at 161-162 won't be easy.
Anecdotal evidence of retail sales and factory orders in Germany slowing down, if accompanied by some slack in labor, may be a harbinger of a shift in ECB policy towards easing in the second half of 2008. Such a development would continue to pressure this spread over the next 12 months or so.

Summary
Overall, the intermediate outlook suggests rangebound conditions without a significant shift in ECB policy and worsening credit conditions.