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Within a market that’s proving to be hard to trade due insufficient consensus about where it’s heading, both the DAX and GBP/JPY are exhibiting signs of an inverted Head and Shoulders pattern, which is bullish during an uptrend. These relatively large patterns display no immediate rush to jump in, but Matt Simpson market analyst at ThinkForex says both could provide excellent reward/risk ratios if timed correctly.

While a break below the weekly lows invalidates the near-term analysis, he says the medium term analysis remains bullish.

There has been a strong correlation between the two markets since the 2011 lows. But with any luck, he says this week’s low’s should hold and for the bullish breakout of the necklines to occur.  

“In the previous analysis I had hoped for a pullback and for a swing low to form prior to a bullish breakout. Instead we traded up to test the descending trend line, until the recent Hanging Man reversal,” says Simpson. “While this warned of near-term weakness, instead GBP/JPY printed an intraday break above, and DAX continues to tease the neckline.”

According to COTS (Commitments of Traders) reports which provide a breakdown of trader positions, large speculators continue to be net long on GBP. But while there has been a reduction of JPY shorts of late, Simpson expects the bearish trend to resume over the coming weeks, to see GBP/JPY appreciate towards his 179 target.  

Indeed, there is potential for a deeper pullback, but as long as the weekly lows hold, then Simpson will be seeking bullish setups to break above the descending trend line. If we break below last Thursday’s low – the Hanging Man reversal – and the support zone, then he expects a deeper pullback.

While we continue to trade beneath the necklines it still raises the risk of a ‘fakeout’ – a failed breakout – and for a deeper pullback. Therefore he says this may be a trade to wait on the sidelines until a more decisive bullish signal presents itself.

But on the plus side, adds Simpson, there’s a clear line in the sand to invalidate current analysis. “A break below the weekly low means we can move on and await bullish setup to appear at a lower level of support,” he says.

With inflation broadly in line within its forecast, The Bank of Japan’s (BoJ) decision to refrain from further easing at their policy meeting on Thursday contributed to the strength in the JPY. Inflation remains broadly in line with the central bank’s forecast, and unless there’s a drop in CPI – or more material deterioration in the domestic economic data – Governor Kuroda is expected to hold back from enacting further stimulus, which could lead to further gains for the currency.

With the BoJ – unlike other central banks – favouring the power of surprise to move currency, Chris Weston chief market strategist at IG says the next move could be two to three months away. Given the current bias, he says the range appears to be capped in response to that expectation.

”While the BoJ is not expected to ease further, the market is expecting changes to its economic projections. Mr Kuroda has been fairly hawkish of late, suggesting the Japanese economy is responding well to its loose stance and is on track to meet the inflation goals that have been set,” says Weston.

With this in mind, he says any dovish narrative that hints at monetary policy easing in the future should see the JPY weaken across the board.

Chris Tedder research analyst at FOREX.com also expects June/July to be the most likely months for more easing if consumer prices take a hit due to the hike in Japan’s sales tax. He says last week’s slew of inflation figures suggest that the bank’s current policy settings are appropriate, at least for the time being.

“After all, consumer prices in Tokyo rose at their fastest pace in 22 years during April, despite an increase in the sales tax earlier in the month,” says Tedder.

Nevertheless, he says it worth noting that the economy took months to feel the negative effects of the last increase in the sales tax in 1997, which suggests Japan isn’t out of the woods just yet.

Meantime, with the daily chart on the DAX – displaying a similar pattern to GBP/JPY – trading just shy of the high, Simpson suspects a breakout is also pending here. With weekly charts within a well established bullish trend – which appears to be increasing with bullish momentum – there’s a strong expectation that this trend will continue. “We have already respected the previous upper bullish channel as support and are now back at the highs, which make me suspect a breakout is pending,” says Simpson.

Some bearish divergence in recent weeks does suggest potential for weakness to the trend. But the fact we’re trading near the highs makes Simpson suspect there’s room for further rallies, before he starts worrying about calling tops.

He recommends traders either seek the Monthly pivot to hold as support and trade above the neckline or wait for the breakout and seek a pullback towards – or onto – the breakout line and seek bullish setups. “If we break below the Monthly pivot then this only affects the near-term analysis and opens the door for a deep retracement as opposed to a reversal. Any return towards the neckline will once again gain my attention.”

Please note that the publication of these comments from brokers does not in any way constitute a recommendation on the part of TheBull.com.au. You should seek professional advice before making any investment decisions.

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