One of the most important principles of FX trading is pairing a weak currency with a strong currency. The reason for doing this is to increase the probability of the future direction of the currency pair.
In the case of the pound, we have seen steady gains all year due to expectations that the Bank of England will have to increase interest rates to deal with staggering inflation in the United Kingdom. This has resulted in a very stretched-long GBP position, but that now looks close to exhaustion. The expectations for the Bank of England are that it may have one or two more interest rate hikes to go, but now investors are looking beyond those hikes and seeing potentially slowing UK growth as the impact of interest rate hikes hits the UK economy.
In contrast, the Japanese yen could be poised for some near to medium-term gains. The Bank of Japan has been increasingly concerned about the weakness of the Japanese yen, and the risk of intervention from the Ministry of Finance is constantly looming over markets, the higher US 10-year yields go, the faster the dollar-yen rises, but also the greater the chances exist that the risk of intervention becomes a reality and yen strengthens. Some analysts see 150 on the USDJPY as a ‘line in the sand’ beyond which the Ministry of Finance will not allow the USDJPY to go.
Furthermore, many analysts expect the Bank of Japan to eventually drop the yield curve control policy, allowing Japanese bond yields to rise and thereby strengthening the yen.
So to conclude, the pound looks due for a correction, and the JPY is potentially poised for gains which should allow a GBPJPY sell bias.
Major Trade Risk: All outlooks have risks and this is no exception. The main risk here is if the Bank of Japan and/or the Bank of England have a change of policy that can quickly alter this outlook. Therefore, keeping a close track of central bank monetary policy is a key risk to keep in mind with this outlook as the GBPJPY could keep gaining despite the stretched GBP position.