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EUR vs JPY: Trading the China Reopening

Traders are eyeing the recent easing of China's strict covid restrictions as possibly laying the groundwork for a forthcoming abandonment of its zero covid policy. In forex markets, both EUR and JPY stand to possibly benefit.

There have been rumours of a potential March reopening date. However, on the back of the protests and clashes which rocked China recently, and the government’s subsequent response in easing some measures, traders are seeing risks that full reopening might be brought forward. 

This view is obviously causing some pretty meaningful shifts in the markets and among these, downside in USD has emerged as the key move to focus on. Away from the volatility seen around the Fed and US rate path projections, the reopening of China threatens to divert a great deal of capital back into Chinese assets, weighing on USD. With that in mind traders are clearly looking for the best USD short options as we head into year end with long short long EURUSD and short USDJPY emerging as the two frontrunners. So, let’s take a look at the factors driving each pair with a view to establishing which is the better play. 

EUR & The Eurozone

Shifting monetary policy divergence has been a major driver of upside in EUR recently, as evidence by the moves we’ve seen in EURAUD and EURCAD. With the ECB still much earlier on in its own tightening program, market expectations are firmly geared towards further, and more aggressive, action from the ECB. This is helping drive EUR higher against currencies whose central banks have already pivoted or are expected to pivot. Consequently, EUR looks set to gain further again the Dollar if the Fed pivots in December as expected towards a slower pace of tightening. 

Given China’s importance as a trading partner for the eurozone, the reopening of the economy is clearly a positive factor. As demand picks up there, so too will demand for eurozone goods, leading to higher import levels from the single customs union. However, China is also a rival. Given that the level of goods sent to the eurozone from China is much higher than vice versa, this leaves the eurozone vulnerable any Chinese hostility, such as we saw during the trade wars ahead of the pandemic and across the course of the Russia -Ukraine conflict. If the Chinese economy regains strength in coming months, China might look to exert fresh dominance over the eurozone which might harm the economy, weakening EUR. 

EURUSD – Weekly Chart

 

Source: FlowBank / TradingView

 

EURUSD is currently testing the bear channel top having rebounded off the lows of the year. If the price can break above this area the next big test will be the retest of the 1.0793 level. This is a major pivot for the market and a break above here will be firmly bullish for EURUSD. While within the channel, however, a further test of support at 1.0089 is still feasible. 

JPY & Japan

JPY has been a major beneficiary of the move lower we’ve seen in USD. As discussed above, the monetary policy divergence between the Fed and the BOJ (which is the starkest in the G10 bloc) has been a major depressing factor on JPY over the year. With a shift in outlook recently, the extended short position in JPY has corrected sharply. 

With China’s status as Japan’s largest trading partner, the reopening of the Chinese economy is expected to boost the domestic economy via higher levels of trade. Additionally, increased travel should also help support the Japanese economy, lifting JPY. Local markets look likely to improve on a number of fronts once travel restrictions and business restrictions are removed in China, potentially at a far quicker pace than we see the same impact on the eurozone economy. 

USDJPY – Weekly Chart

 

Source: FlowBank / TradingView

 

USDJPY has corrected significantly from the highs of the year. With the price recently breaking below support at the 139.02 level the focus is on a test of the 130.71 level next. However, the pair is still within a strong bull trend and until the 130.71 level is broken, the medium-term bias remains in favour of a further push higher, at least for once more run towards the 147.64 level. 

So which one? 

The issue for Japan is that the BOJ is showing no signs whatsoever of any intention to raise rates in the near term.  The BOJ stands alone in the G10 where all other central banks have tightened this year. However, the extended currency price decline in itself may be enough to galvanize yen bulls if China does press ahead with the reopening.

The ECB moving forwards with tightening, including a recent exit from NIRP supports the EUR in any China reopening trade but this will need to offset the clear recession risk brought on by the Russia/Ukraine war and energy crisis. 

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