USD/JPY Forex Forecast – Uncertainty Over Size of Next Fed Rate Hike Weighs

The Dollar/Yen is drifting lower on Friday as traders assess the path of Federal Reserve policy. The Yen, which is particularly sensitive to U.S.-Japanese long-term interest rate differentials, is threatening to extend its recent losing streak to seven weeks, even as it gained a little ground on Friday with 10-year U.S. yields retreating from a nearly four-month high close to 4.1%.

At 07:49 GMT, the USD/JPY is trading 136.466, down 0.289 or -0.21%. On Thursday, the Invesco Currency Shares Japanese Yen Trust ETF (FXY) settled at $68.19, down $0.22 or -0.32%.

Fed Officials Wrestling with Inflation Data

U.S. Federal Reserve officials wrestled Thursday with whether recent data showing inflation, jobs and spending all hotter than expected was a “blip” or a sign that even higher interest rates could be required to slow price rises, Reuters reported.

The separate comments from Fed Governor Christopher Waller and Atlanta Fed President Raphael Bostic posed a question central to the next phase of the Fed’s battle to lower inflation:  Is monetary policy again slipping behind the curve of a surprisingly strong economy that needs even tighter credit conditions, or is slower growth and lower inflation already in train?

Fed Governor Christopher Waller’s Hawkish Tone

“Last month we received a barrage of data that has challenged my view…that the Federal Open Market Committee was making progress in moderating economic activity and reducing inflation,” Waller said on Thursday.

“It could be that progress has stalled, or it is possible that the numbers released last month were a blip,” he said.

If upcoming data shows the economy moderating and inflation slowing, Waller said he would “endorse” the target federal funds rate rising to roughly the same spot policymakers projected as of December, when 13 or 19 officials saw rates coming to rest somewhere from 5.1% to 5.4%.

The current policy rate is set in a range between 4.5% and 4.75%.

“On the other hand if those data reports continue to come in too hot, the policy target range will have to be raised this year even more to ensure that we do not lose the momentum that was in place,” Waller said.

Atlanta Fed President Takes Some Steam Out of Dollar/Yen Rally

Bostic also said he was ready to raise rates higher if upcoming data did not show inflation “clearly” heading back towards the central bank’s 2% target from its January level of about 5.4%.

But he also felt the impact of Fed rate increase so far may only be getting started, a reason to be careful in deciding on further rate hikes lest the central bank overstep.

“Slow and steady is going to be the appropriate course of action,” Bostic said in comments to reporters, with perhaps only two more quarter point increases needed before the Fed can pause.

Fed rate increases “should bite through the spring … Going at a measured pace reduces the likelihood we overshoot” and damage the economy.

Short-Term Outlook

With the Bank of Japan (BOJ) expected to start to dismantle extraordinary stimulus measures some time after Governor Haruhiko Kuroda retires next month, the short-term focus is going to be primarily on upcoming labor market and consumer inflation data, and Federal Reserve policy.

These factors should be the source of heightened volatility with the USD/JPY expected to swing in both directions until the market determines whether the Fed is going to raise rates by 25-basis points in March or by 50-basis points.