USD/JPY outlook: Yen shorts flushed again as history points lower

• Yen shorts cleared out at near-historic pace
• Positioning flipped long for first time since February
• Historical reversals have often favoured further yen strength
• Technical picture continues to favour USD/JPY downside

Yen shorts cleared out at historic pace

USD/JPY has seen a huge unwind over the past couple of weeks, and we’ve just found out that a large chunk of that move may have been driven by a significant clear-out of short-yen positioning among speculators, according to the latest data released by the CFTC on Friday.

The scale of the shift was enormous, with net speculative positioning swinging from around 92,000 contracts short to almost 11,000 contracts long in the week to September 8. While this is not a reflection of total positioning across the FX market, it does provide a useful sense of how aggressively speculators have shifted over recent weeks.

To put the unwind into context, going back to 1986, we’ve only seen one larger reversal in short positioning, and that happened to arrive in early August this year. Net speculative positioning has also flipped long for the first time since late February.

Source: LSEG

So we’ve now had two historic clear-outs in a little over a month, providing a strong indication that the vulnerabilities created by stretched speculative short positioning have been largely removed.

That doesn’t mean the risk of further yen strength has disappeared. Forced short covering among futures speculators is one thing. A broader unwind in yen-funded carry trades is another, and the latter could be significantly larger if falling asset prices or a further deterioration in risk appetite forces investors to reduce leveraged positions.

History points to further yen strength

Even without that broader carry unwind, history suggests abrupt reversals in speculative positioning have often been followed by further yen strength. Looking at previous occasions where net speculative yen positioning improved by more than 40,000 contracts in a week while starting net short, USD/JPY was lower one week later in 60% of instances, two weeks later in 93%, and four and eight weeks later in 67% of cases.

Source: LSEG

The clearest pattern came over the following fortnight, with USD/JPY lower two weeks later in 14 of the 15 instances. Outcomes ranged from a decline of around 4.6% to a rise of 2.1%, with an average fall of 1.2%.

Clearly, past performance is not indicative of future returns, and just because a pattern has occurred regularly in the past does not mean it will be repeated on this occasion. But the results do suggest that a major clear-out in speculative shorts has not historically meant the downside move in USD/JPY was exhausted.

Bearish technical bias remains intact

Source: TradingView

If that historical pattern were to continue, the immediate focal point would be 152.90, where the pair bounced twice last week. Beneath that, 152.10 is a swing low from January, before 151 comes into view. The latter is a far more important level, having acted as both support and resistance on multiple occasions over several years. If we were to see a substantial downside unwind, other levels of note include 149.40 and 146.

Above 154.50, 155.50 repeatedly acted as support over periods this year and may now flip to offering resistance. Beyond that, 156.68 and 158 are other levels of note before the 200-day moving average.

The message from the price action and oscillators continues to favour a bearish bias. The string of lower highs and lower lows remains intact, the medium and long-term moving averages are flattening out or beginning to roll over, and the price remains beneath all three. RSI (14) sits around 30, while MACD is pushing further into negative territory after already staging a bearish crossover.

As such, the preference remains to sell into strength and downside breaks.

Fed, BOJ and energy remain key risks

While the technicals and historical tendencies favour continued downside, there is no shortage of known and unknown macro risk events for USD/JPY traders to navigate this week.

The Fed and BOJ decisions on Wednesday and Friday respectively are the obvious risks, while energy price fluctuations could also have a significant influence on direction. We’re already seeing evidence of the latter in Asian trade on Monday, with USD/JPY trading higher after a surge in crude futures.

I’ve gone into those factors in far greater depth in the week-ahead report released over the weekend.