High Beta Currencies Benefit From Year-End Short Squeeze, Reflecting on GBP/JPY Top Trade

[MongiIG]

FX Analysis and News

• Year-End Short Squeeze Benefits High Beta Currencies
• Reflection on GBP/JPY

As I mentioned yesterday, this is one of those weeks where you should not read too much into market moves. Thin volumes will likely exacerbate much of the price action we have seen over the past few sessions, most notably across the FX space. To me, this looks like a year-end squeeze in positioning and taking a look at the COT report, those currencies that have seen the largest increase in net shorts over the past month are currently seeing a short squeeze, particularly against those currencies that have seen a build-up in net longs. As such, cross-yen has seen a notable pick-up with the help from a bid in stocks and a rise in global bond yields.

Year-End Short Squeeze

Source: Refintiiv

However, unfortunately, the rally across in cross-JPY, in particular GBP/JPY, means that my top Q1 2022 trade of long GBP/JPY is outdated with the near 350pip rally over the last three sessions hitting my topside target of 153.00. That said, this does not mean I don’t expect GBP/JPY to perform well in Q1, but the risk/reward appeal has diminished somewhat since the beginning of the week. Therefore, I will reassess at the start of next year.

Below is my rationale for expecting GBP/JPY upside

Long GBP/JPY – Carry trades hasn’t exactly been at the forefront of investors minds across the FX space in Q4 amid a sizeable unwind in reflation trades. However, should we see risk sentiment stabilise in the new year, GBP/JPY can once again look to rate differentials for direction.

GBP/JPY vs GB/JP 10Y Differentials

Source: Refinitiv

Taking a look at past BoE hiking cycles, GBP/JPY has had a tendency to grind higher with a hit rate of 83%. What’s more, with COT data highlighting that traders are the most bearish on the Pound in over 2yrs, there is fuel for a short squeeze to prompt a reprieve in the Pound. The risk, however, is the rise in political instability risks with the government officials unable to keep themselves out of the limelight for the wrong reasons. To add to this, money market pricing is also a worry for the Pound, given how aggressive markets are priced for BoE tightening.

On the technical front, key support is situated at 148.50-149.00, failure to hold would negate the view of GBP/JPY upside. Topside targets are for 153.00-50.

GBP/JPY Weekly Chart

Source: Refinitiv

 

By Justin McQueen, Strategist, 23rd December 2021. DailyFX