The Pending EUR/JPY Breakout

01/09/2009 11:30 am EST

Focus: FOREX

Risk sentiment is perhaps one of the largest uncertainties behind the broader markets at the beginning of this new year. Over the first few days of the new trading week, optimism seemed to make its tentative rebound as equities rose, credit market indicators improved, and a few of the yen crosses turned higher (most notably USD/JPY). However, there is little support for this reversal from a fundamental standpoint.

There is little hope for growth to show immediate signs of improving, credit is still frozen as financial institutions hoard cash to boost reserves, and dominant bear trends across the capital markets will keep pressure on any swells in confidence. However, the outlook still seems relatively mixed through the Japanese yen—the consummate risk gauge. USD/JPY caught wind of a strong dollar, the franc has long put in for a rebound since the SNB cut rates, and the eternally weak pound has even seen a reversal.

Alternatively, while a short-term rebound seems to have countered the fundamental outlook for many of the yen crosses, EUR/JPY has held to its congestive pattern, building pressure behind what may be an inevitable breakout.

Chart

Looking at the pair's layout, EUR/JPY has indeed marked a short-term bottom in late October, but this has turned to consolidation rather than a reversal. Such sideways price action does not last long—especially in a pair as historically volatile as this one. So, looking at the symmetrical wedge that has developed over the past few weeks, it is reasonable to expect a breakout that may very well follow the next major shift in risk appetite.

For technical milestones, the trend lines that have carved the wedge will act as immediate trigger points for direction. The trend beginning with the December 18th swing high now holds around 127.75, while the rising floor is at 125.25. Looking at scenarios for a breakout to either side, it is clear that the wedge can give way relatively easily. Should risk aversion find traction once again amongst the crosses, it would sweep up the sidelined EUR/JPY, and a confirmed move below the 38.2% retracement of the December advance at 125 will mark a good jumping point. For a genuine revival of confidence, it will be more difficult to shake this pair's skepticism (technically and fundamentally).

The wedge would give way easily enough, but a large 38.2% retracement at 130 and range top at 131 will present staggered hurdles that will be hard to overcome. Therefore, it will be best to wait for a confirmed daily bar close at least above 130 (and more reasonably above 131).

By John Kicklighter of DailyFX.com

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