Hu Yuexiao, economist at Shanghai Securities noted that “...an advancing dollar and weak economic fundamentals in China caused the capital outflows, which will probably continue this year. So the central bank will keep intervening to keep the currency stable...”

The point of the matter is that both the ECB and the BOJ are facing similar, unexpected QE consequences. In a nutshell, the theory behind QE is that if the yields of safest regional fixed income asset classes, most government bonds, and overnight deposit rates are driven as low as possible, those actions will forces capital into the private sector economy and government infrastructure projects. In reality, fund managers are being forced to purchase sovereign fixed income assets as currency reserves which may partly explain the continuing demand for negative yielding sovereigns.   

In 2005 former Federal Reserve Chairman Ben Bernanke noted the phenomenon by detailing the effect capital inflows were having on long term interest rates.  In particular, an enormous amount of foreign capital is draining the reservoir of U.S. Treasuries faster than they can be issued. Ten years later, Mr. Bernanke premise has proved prophetic. Both the Yen and the Euro are accepted reserve currencies, and indeed as Mr. Yamashita of Deutsche Securities noted above, the JGB rates are being affected by an increasingly illiquid JGB market. The situation in Europe has proven similar. As of 15 April, 2015 bond exchange traded funds have attracted $35.7 billion according to BlackRock Inc. About 39.2% or $14 billion in USD are inflows from Europe.

The point of the matter is that EUR/JPY is very much a function of central bank speeches or actions, ECB, BOJ and the US Fed.

forex, market liquidity, illiquidity, euro yen, EURJPY, EURJPY, Bank of Japan Effect of Illiquidity EUR JPY Chart
EUR/JPY chart

A quick examination of a 52 week chart of EUR/JPY demonstrates the effect of central bank actions and reactions beginning with the BOJ surprise expansion of its asset purchase program. Before the programs expansion, EUR/JPY traded within an uneventful channel. After the BOJ expansion, the pair broke out of its rather sedate range and responded more sharply to event dates. Support and resistance lines are clearly demonstrated on the Fibonacci retracement study. Lastly, it’s not unreasonable to say that mangers are looking for liquidity as much as yields. Since the JGB market is more limited in scope than the EU government bond market, it seems reasonable to assume that EUR/JPY has the potential to trade lower.   

Mike Scrive
Technical Analyst
Accendo Markets

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