What to Know
- Elevated U.S. real yields continue to support demand for the U.S. dollar.
- Markets are pricing in a potential 25-basis-point Federal Reserve rate hike in December.
- USD/JPY has been consolidating between ¥156.50 and ¥159 since mid-September.
- A breakout from the USD/JPY range could produce a measured move of approximately 250 pips.
- The interest rate differential between the Federal Reserve and Bank of Japan supports the dollar against the yen.
- USD/CHF is approaching its 50-day EMA at 0.8218, a key technical level.
- A daily close above the 50-day EMA could create an opportunity to build a bullish position in USD/CHF.
- The 200-day EMA is an important downside level to monitor for USD/CHF.
- Interest rate differentials and carry-trade opportunities remain important drivers for both currency pairs.
The fundamental backdrop that we see in the markets at the moment is elevated and tight rates, as well as real rates in certain countries, one of which, of course, is the United States. The United States operating a real rate, which means that if you hold a bond, it pays more than actual inflation, meaning it actually pays you a return over time, makes a case for a stronger U.S. dollar.
We have seen a lot of evidence of an inflationary environment in the United States that should continue to keep the Federal Reserve somewhat tight. When you contrast that with other central banks around the world, you start to see potential winners and losers. As we get the CPI report today, that will be yet another piece in the puzzle, although it should be stated that the FedWatch tool suggests that there is something like an 83% chance that the Fed hikes rates by 25 basis points in December. The market pretty much has that baked in.
Nonetheless, one way you can take advantage of this is to buy the dollar against low-yielding currencies.
USD/JPY
The first currency I'm looking at is the Japanese yen. The U.S. dollar has been very sideways against the yen for some time now, going back to the middle of September, but that's actually a good thing. You want to get paid at the end of every day without massive fluctuations, unless, of course, they're going in your favor. So carry traders have done quite well here.
They've just gone back and forth between ¥159 at the top and ¥156.50 at the bottom. Once we break out of this range, the measured move, which suggests 250 pips, would be a potential target. The Bank of Japan is in a little bit more of a predicament than the Federal Reserve, so keep that in mind.
The Federal Reserve, like I said, is likely to hike rates. If they still sound hawkish in December, that could be a catalyst for this thing to really take off to the upside. I prefer to buy dips here and have been doing so.
USD/CHF
Another pair that you can take a look at through this prism is the U.S. dollar against the Swiss franc. The Swiss National Bank has a zero interest rate policy and has reiterated that recently, despite the fact that there has been a little bit of inflation in Switzerland. Almost all of it falls at the feet of energy, though, so that is worth noting.
If the market breaks above the 50-day EMA on a daily close, currently sitting at 0.8218, then I'm going to start building a position to the upside. Again, this is a situation where you get paid swap at the end of every day to hold it. It's really not until we break down below the 200-day EMA that I'd be concerned about this pair.
With the Swiss National Bank reiterating its zero-rate intentions and the fact that the Federal Reserve is going to raise rates again, you're looking at a 425-basis-point spread between the two, roughly, and that is going to probably give this thing a little bit of lift throughout now to the end of the year.
Frequently Asked Questions (FAQs)
Why is the U.S. dollar strengthening against the yen and Swiss franc?
Higher U.S. interest rates and positive real yields make dollar-denominated assets more attractive compared with currencies from countries maintaining lower interest rates. This creates demand for the U.S. dollar.
What is the key resistance level for USD/JPY?
USD/JPY faces resistance around ¥159. A breakout above this level could trigger a measured move of approximately 250 pips, according to the technical outlook.
What is the key support level for USD/JPY?
The lower boundary of the current consolidation range is around ¥156.50. A break below this level could weaken the bullish outlook.
What happens if USD/CHF breaks above its 50-day EMA?
A daily close above the 0.8218 level could signal improving bullish momentum and provide an opportunity to establish long positions.
What is the important downside level for USD/CHF?
The 200-day EMA is the key technical level to monitor. A break below this moving average would raise concerns about the pair's bullish structure.
What is a carry trade in forex?
A carry trade involves borrowing or selling a currency with a relatively low interest rate to buy a currency offering a higher interest rate. Traders may earn the interest-rate differential, although exchange-rate movements can offset or exceed those returns.
How do interest rate differentials affect USD/JPY and USD/CHF?
When U.S. interest rates are significantly higher than Japanese or Swiss rates, investors may prefer holding U.S. dollars to benefit from higher yields. This can support both USD/JPY and USD/CHF, although central bank decisions and currency intervention risks can influence the trend.