We’ve seen this movie before. For years, the yen carry trade has been a critical element of the equity price support toolbox. But, all good things must come to an end. When the yen gets too cheap, Japanese inflation becomes problematic as the cost of importing food and energy soars.

Aside from exposing the ludicrousness of its monetary policy, Japan’s recently unveiled 0.0-0.1% interest rate regime speaks volumes to the pressures of trying to balance economic reality with the desire for ever higher stock prices.

Slamming the yen’s value works fine – to a point. But, as rising food and energy costs pressure the real economy, something has to give.

Enter the euro.

continued for members…

It has largely taken the place of the yen carry trade, but with a twist – framing a cheaper USD as the best signal/instigator of rising stock prices.

The trick was pretty easy to see over this past couple of years. The EURUSD’s dramatic 17% rally from the Sep 2022 lows corresponded with SPX’s lows. And, SPX was able to make new highs whenever EURUSD pushed to new highs – especially if a breakout occurred.  Conversely, whenever EURUSD tumbled (and, breakouts failed), SPX corrected.

We’re seeing it these past couple of days, where EURUSD’s breakouts above the red channel top and white channel top have both failed, contributing to the current backtest.

Oil became quite cheap for a few minutes during the pandemic, but oil in euros rose so sharply…

…that inflation soared to over 10%…

…and the ECB was forced to raise interest rates to compensate.

Of course this eventually caught up with the real economy, hammering GDP to the point where it was barely positive in Q4 2023.  Similar to the situation in Japan, the ECB is now faced with a conundrum. Bringing down interest rates would help stimulate a faltering economy. But, it would also risk another bout of inflation, especially with oil and gas prices on the rise.

Lower interest rates would also likely hammer the value of the euro, which would help exports but might ding stock prices.  Bottom line, there are no simple solutions to a situation made so messy due to years of manipulation rather than market forces dictating the relationship of currencies to one another.

In any case, this is what the charts suggest.

EURUSD’s retreat from its brief (compared to 2020-2022) breakout above the falling red channel is bearish. But, it’s ability to hold the bottom of the less steeply falling purple channel suggests that the ECB won’t let it make new lows.

For a while, it appeared that another drop to the purple midline or .234 line was likely. This would ideally have corresponded with a return to the small rising red channel bottom at the white .618 Fib at 1.0203 around early February. But, instead, we’ve had these periodic rallies in EURUSD that have – at the very least – postponed a drop.

And, it hasn’t been without justification. As long as the ECB maintains rates where they are, why should the euro’s value suffer? As stated above, however, a recession is looming. If the ECB hopes to avoid one, it must lower rates. Q1 is already in the books and probably won’t be pretty – especially relative to the US’ expected 2.8%.

Bottom line, the US has every reason in the world to cut rates – but, might not anyway. The ECB desperately needs to cut rates, and probably will. This should continue to chip away at the EURUSD, with the most likely target shown below.

USDJPY is much easier from a charting standpoint.  The monthly falling white channel intersects the rising purple channel at some obvious Fib levels.

The upside targets, should it break out to new highs, are the purple 2.24 at 159.14 and the combined white 1.272/purple 261.8 at 167.25-169.29.The SMA200 at 146.84 at 146.84 is good downside protection, as the pair has remained above it since May 2023. A breakout would allow NKD to reach its obvious upside target of 46,500-48,145, probably around year-end.

While any near-term breakdown looks likely to be supported by the SMA200 at 36,770 in May.

Putting all this together, it looks like DXY should continue to push higher with our 107.11 target still in force. Ironically, both GC and SI are doing quite well during this period of USD strength. GC has broken out, and SI is threatening to follow suit.

GLTA