Will the dollar-yen rise again?

It might not look like much on the monthly chart, but the U.S. dollar- Japanese yen rate (USD/JPY) just concluded a three-month run during which it rallied nearly six percent after touching a conspicuous support level chart watchers had in their sights for years.

With talk of the dollar-yen breaking through the psychologically loaded round number of 100 for the first time in nearly 20 years (see “Will this be the year 100.00-yen gives way?” Currency Trader, March 2005), all eyes were on the currency pair around year end. But after hitting a low of 101.67 on Jan. 17, USD/JPY rallied as high as 107.61 — its highest level in 22 weeks.

The rally looks more robust on the daily chart, which shows price recently hurdling the Feb. 10 high as well as the Nov. 10 high (dashed line). The question is whether this is just a temporary bounce as technicians came in to buy around support, or the beginning of something bigger.

Let’s consider some numbers. Over the past 20 years, a rise of 5 percent or more (from low to high) in the USD/JPY over a three-month period has occurred 93 times. However, many of these instances are part of longer runs of overlapping three-month periods that rose 5 percent or more. (For example, if USD/JPY rose 5 percent from January to March and again from February to April, that would constitute two instances.)

It summarizes the different runs of consecutive three-month periods that rose 5 percent or more from March 29, 1985 to March 29, 2005. There were only three other times a single three-month period rallied more than 5 percent. The longest run was 10 months, and the most frequently repeating — i.e., the mode — run length was two months, which occurred seven times. (The average and median runs were 3.46 and 3 months, respectively.) What this data suggests is that when the USD/JPY rises more than 5 percent in a three month period, more than 89 percent of the time it will rally at least that much over the next (overlapping) three-month period. This, in turn, implies the currency pair would rally to at least 108.51 in April, which is 5 percent above the February low of 103.35. What about that 22-week high? We searched for past instances when USD/JPY made a 22-week high and the most recent two weeks both had higher highs and higher lows than their immediately preceding weeks — the condition the market was in at the end of March.

It shows an upside bias to the following five weeks. The odds of a higher close at the end of the five subsequent weeks is above 50 percent and the average and median returns are positive. By week 6, though, the odds are only 47.62 percent for an up move, and although the average gain is still slightly positive, the median gain is -.36 percent. Also, the largest up moves (LUM) are larger than the largest down moves (LDM) at all the intervals.

These are not blockbuster numbers, by any means. However, together with the fact that virtually every off-the shelf technical indicator was recently signaling the market was overbought and/or turning from downtrend to uptrend, there are bound to be traders looking to enter into an incipient uptrend.

If a longer-term trend materializes, its viability will depend on the larger factors that impact the dollar and other major currencies. (Our cover story this month discusses one of the factors, the deficit.) To analyze a recent trade example in the USD/JPY, see this month’s Forex Trade Diary.