barely responded to softer US data and falling bets last week. With the calendar thinning, the price action may be the more important signal.
- USD/JPY shrugs off softer US data
- Fed rate hike pricing continues to retreat
- US-Japan yield spreads keep compressing
- Yen shorts decline despite USD/JPY rebound
- Thin calendar puts focus on price action
USD/JPY was given every excuse to decline last week and didn’t. Perhaps there is a message in that. US data whiffed, market pricing for Fed rate hikes declined and yield spreads between the US and Japan narrowed further, yet none of it generated meaningful downside. And with a very limited data calendar in the week ahead, it is difficult to see a known catalyst emerging that could change the current dynamic.
Fed Pricing Follows the Data
The last week and a bit was an unusually soft one for the otherwise high-flying US economy. It started with the disappointing report the previous Friday, followed by softer-than-expected and upstream inflation reports. It was then rounded out by the first decline in US in nine months, and a large one at that, raising questions about whether consumer spending can continue to hold up in a high-inflation environment with tailwinds from tax cuts looking firmly in the rearview mirror.
The deterioration is evident in Citi’s Economic Surprise Index below, which has rolled over sharply following the run of undershoots. While the index remains in positive territory, it is now well below the levels seen earlier this year, indicating data beats are becoming increasingly rare.
Source: LSEG, FOREX.com
And as the data has softened, so too has market pricing for Fed rate hikes looking out to the middle of next year. Back in late July, around two and a half hikes were priced according to the futures curve. That has now fallen to just 38 basis points, equivalent to around one and a half hikes. The direction of travel is obvious.
Source: TradingView, FOREX.com
Even with hawkish commentary from some Fed officials, it is becoming difficult to make the case for raising rates in the current environment, with a growing proportion of the data pointing to activity rolling over.
Source: TradingView, FOREX.com
It’s not just the front of the US interest rate curve that is seeing an adjustment, with spreads between US and and 10-year yields continuing to compress. That also reflects growing expectations the Bank of Japan may lift rates sooner, and potentially by more, than markets currently have priced.
Short-Term Yield Sensitivity Returns
What stands out from the correlation matrix below is that while the relationship with US Treasury yields and yield spreads has strengthened rapidly, that has not translated evenly into USD/JPY price action. While the US interest rate outlook is clearly influencing the pair, the response has been asymmetric. When yields and spreads decline, the move lower in USD/JPY is minimal. When they rise, the gain in USD/JPY is far larger, reflecting the buoyancy in the pair.
Source: TradingView, FOREX.com
There is also some evidence that renewed tensions in the Gulf may be playing a role. With negotiations between the US and Iran no longer taking place, according to recent reports, Japan’s vulnerability as a major energy importer has come back into focus, creating both economic risks and potential headwinds for the yen through a deterioration in the terms of trade.
What is also absent is the relationship with risk appetite. USD/JPY has often shown a strong connection with broader risk proxies, but there is little evidence of that right now. Correlations with VIX futures and S&P 500 futures are either negligible or running contrary to what would normally be expected.
Yen Shorts Continue to Ease
Source: LSEG, FOREX.com
Despite the continued upward drift in USD/JPY, the latest COT report from the CFTC revealed another small decline in net short yen positioning among speculators last week. While only reflective of one part of the broader FX market, it suggests speculators are not rushing to rebuild yen shorts despite the rebound from the low struck earlier this month.
Japan GDP, Fed Minutes Lead a Quiet Week
After a busy week of key data, the calendar thins heading into the second half of August, with few releases that look capable of meaningfully influencing USD/JPY. A number of releases have been left off the list below because they screen as more noise than signal, with only those that may have some influence on the pair included.
Source: TradingView, FOREX.com (US EDT)
Japan’s preliminary Q2 report is released early Monday morning in Asia. With a BOJ rate hike in September now heavily favoured, a weak outcome screens as the bigger risk for the pair, potentially raising doubts about whether policymakers will be willing to lift rates into an environment of disappointing activity data. National inflation figures arrive on Friday, although they rarely generate much volatility given Tokyo inflation data is released around three weeks earlier and provides a strong steer on the national numbers.
In the US, the calendar is also thin, although it will be interesting to see whether the softness evident in some of last week’s hard data shows up in the flash PMIs on Friday. There was no evidence of that in July, but markets will be sensitive to any signs that momentum is weakening.
Arguably the release most likely to move the dial for USD/JPY is Wednesday’s FOMC minutes, providing further insight into deliberations at a meeting where three regional Fed presidents dissented in favour of a hike. Was there evidence that additional members were shifting towards the view of the dissenters, or were they outliers? While the first set of minutes released under Kevin Warsh’s leadership was short, there should still be enough information for traders to digest when it comes to the outlook for the funds rate.
Dips Continue to Find Support
Source: TradingView
Turning to the technicals, the long downside wicks on the daily candles last week exemplify the buoyancy in USD/JPY and reaction function to softer US economic data. The uptrend from the Liberation Day lows in April last year down to support at 158.58 forms a zone that has repeatedly absorbed offers, helping the pair reverse higher into the close. For now, that remains the immediate focal point underneath where the pair trades.
Overhead, 159.60 is the first level to watch after the pair stalled around the 50% retracement of the intervention-driven decline. Above that, the confluence of the psychologically important 160 level with the 100-day moving average is the next hurdle for bulls, followed by 160.73, which acted as both resistance and support earlier this year.
Should the support zone down to 158.58 be broken, the 200-day moving average at 158.19 and 156.68 are the next downside levels of note, with a break of the latter increasing the potential for an unwind towards 155.60, the support zone that sparked strong reversals during both intervention episodes this year.
The oscillators are sending a more neutral message, putting greater emphasis on the price action. While the fundamental backdrop may argue for USD/JPY downside, the resilience seen last week suggests the path of least resistance may still be higher in the near term.
On the weekly chart, while the rebound was not strong enough to complete a morning star reversal pattern, the size of the weekly gain is still noteworthy.
