Note: We’ll be taking the next week off due to the Christmas and New Year holiday season. The weekly Fx analysis and the weekly newsletter trade ideas will return after the New Year in the first week of January.

BOJ Meeting - What Happened?

The big story in markets this week is the announcement by the Bank of Japan to adjust their YCC (yield curve control) policy. If you remember, the Bank of Japan has kept Japanese Government bond yields fixed at around 0% since 2016, with an allowed tolerance band of +/- 0.25%. The 10-year Japanese bond was trading at the upper end of the band near 0.25% as yields in other countries surged due to high inflation this year.

Yesterday, the BOJ announced they are now widening the band to +/- 0.50%. Japanese yields immediately surged above 0.25% and are now approaching the new upper band at 0.50%. Although it’s not such a huge move by itself, the markets are taking it as a massive change and view it as the first step of the BOJ tightening monetary policy. Investors now expect the BOJ to hike rates by summer next year! This is why we are seeing such huge moves in JPY pairs this week.

It was also quite a surprise move as few expected the BOJ to make this change ahead of the Christmas holiday period when markets are trading on thin liquidity. Nonetheless, it is not a complete surprise because inflation in Japan is also rising recently, although only very gradually. This was already causing some speculation in the market that the BOJ would eventually need to make such a policy adjustment to the YCC. So, we are not surprised by the BOJ’s decision, only we didn’t expect it to happen this week.

The market has already settled in a narrow holiday trading range (as seen on major Fx pairs like EURUSD and GBPUSD). So, we should be careful trading in the current environment.

That said, there is no denying that the potential for GBPJPY to extend the drop lower exists and is real. The massive JPY strengthening led to a huge drop across all JPY pairs. USDJPY is down more than 500 pips than before the BOJ, while GBPJPY dropped around 600 pips yesterday.

In the meantime, the GBPUSD major pair is testing key support at the 1.21 zone. A break lower could lead to a quick move lower toward 1.18 (as we noted in the weekly Fx analysis this Monday). In fact, GBPUSD falling from here now seems like the probable scenario, only some catalyst is needed to break that support at 1.21. And with stocks looking poised to drop further, we may get that catalyst sooner rather than later.

With the outlook looking bearish for both USDJPY and GBPUSD, the best way to capitalize on those potential moves is by shorting GBPJPY. If GBPUSD reaches 1.18 and USDJPY falls to 130.00 – both of which look likely – then GBPJPY should soon be trading at the 155.00 - 156.00 area. This is the target zone for this short GBPJPY trade.

Only a word of caution, given the circumstances: 

The volatility on JPY pairs is now very high. This means there can be further swings in both directions. Just a simple 38.2% or 50% correction can pull GBPJPY back higher some 200 - 300 pips or more. This is an important aspect to keep in mind in the current situation when shorting GBPJPY. That said, aside from the volatility, the target is some 500 pips lower, so this trade looks worth taking.

Given the above, it’s a bit tricky to pinpoint a short entry on GBPJPY with a relatively tight stop. Entries around current levels (159.00-160.00) are appropriate, with a target of 155.00, as noted above. GBPJPY should not make a move above 164.00, so this can be used as a stop loss. But as said above, this is a little unusually wide stop loss, so to bear any potential volatility, we need to adjust our position size down.

A potential safer entry would be once GBPUSD completes a breakout below 1.21. This should unlock a faster move down and lead GBPUSD to 1.18. Such a scenario should also accelerate GBPJPY lower too, allowing for a little tighter stop loss.