USD_JPY collapsed from 90.60 to a low of 88.65 in 30 minutes taking down AUD_USD from 88.00 to 86.15. The Scale of Market Quakes for AUD_JPY recorded a strong quake of 4.4. Three trades triggered the move: margin calls on long AUD positions, liquidations of short JPY and short USD positions. The market was building up to such a move because there was a bifurcation in the market, where one group of traders believing in the long-term collapse of the USD turned a blind eye to their increasing losses due to the gradual rise of the USD, while on the other hand there were the traders with the growing confidence in the continued strengthening of the USD. Similar to children that rock a rowing boat the combination of margin calls and aggressive trend following trades triggered the sell off.
What do we make of all this? We are at the start of the month, so it is unlikely that this is the last storm. Traders will want to make up for any losses incurred, so they will increase their bets. If tomorrow Nonfarm payrolls are equal or worse than expected, we might see a strong wave of selling of the USD reversing the USD appreciation. If this happens, then the natural response of traders, who failed to participate in the rise of the USD is to jump ship and turn their positions from shorting the USD to going long. From my point of view, this would definitely be a mistake. The USD has staged a strong recovery over the past few weeks. There are growing signs that the USD longs are becoming increasingly exuberant an early indicator of a pending reversal.

At the same time, as the currency moves, gold dropped from 1105 USD to a low of 1063. Under normal circumstances one would expect that talk of government default would provide support for gold, but this was not the case. The dynamics of margin calls can create havoc with fundamentals, as witnessed with gold. So at all times it is important to trade with sufficient reserve margin capital.

Most likely, the coming days will be volatile. If the Nonfarm Payrolls are positive, then the appreciation of JPY will continue for another two days, because markets are illiquid on Friday afternoons and it only takes a small volume to move the price even further, triggering more margin calls. When a reversal finally starts, traders need to be careful and not jump ship. The USD downtrend can be far stronger because there will be another round of margin calls, but this time for the traders, who are long USD.