USD/JPY Fundamental Daily Forecast – Treasury Yield Plunge Will Shift Momentum Dramatically

The Dollar/Yen is inching a little higher early Wednesday after closing lower the previous session in reaction to a drop in U.S. Treasury yields and improving risk sentiment.

Japanese officials continued to warn about excessive volatility, but after back-to-back interventions on Friday and Monday, the trade was relatively stable. Traders are now bracing for Friday’s Bank of Japan (BOJ) monetary policy meeting.

At 00:33 GMT, the USD/JPY is trading 148.072, up 0.125 or +0.08%. On Tuesday, the Invesco CurrencyShares Japanese Yen Trust ETF (FXY) settled at $63.17, up $0.50 or +0.80%.

Treasury Yields Decline on Fed Policy Concerns

Treasury yields fell on Tuesday as uncertainty over future Federal Reserve policy weighed on markets. Weaker-than-expected U.S. economic data also raised a few red flags over whether the Fed could continue to raise rates aggressively given the quickly weakening U.S. manufacturing and housing sectors.

The yield on the benchmark 10-year Treasury note was last down by around 17 basis points to 4.067%. This move helped narrow the spread between U.S. Government bond yields and Japanese Government bond yields, making the U.S. Dollar a less-attractive asset.

One reason for the drop in yields was the growing uncertainty about the Federal Reserve’s policy path. Investors are beginning to question how long the central bank will continue hiking interest rates and by how much they will be increased.

After weeks of hawkish comments from Federal Reserve speakers, which indicated that rates would be hiked until inflation declined, the Wall Street Journal reported on Friday that some central bank officials were starting to feel uneasy about the speed of the hikes.

BOJ Seen Keeping Ultra-Low Rates as Officials Shrug-off Yen’s Slump

The Bank of Japan is expected to raise its inflation forecasts on Friday but keep ultra-low interest rates steady in a show of resolve to support the fragile economy, even at the cost of accelerating an unwelcome fall in the Yen to fresh 32-year lows.

With inflation modest compared with western nations and Japan’s economic recovery still fragile, the BOJ is set to leave intact its minus 0.1% target for short-term interest rates and the target for the 10-year bond yield at around 0% at its two-day policy meeting that ends on Friday.

Short-Term Outlook

We’ve said several times in the past that the only way the USD/JPY would weaken would be change in Fed policy to less-hawkish or a change in BOJ policy to less-dovish. Well the BOJ is not expected to change, but based on the current chatter, the Fed could relax its aggressive stance and signal it was willing to slow down the pace of its rate hikes.

It looks as if the Fed will raise rates by 75-basis-points at its November 1-2 policy meeting, but policymakers could signal that this is the last of the huge rate hikes this year. This statement would be enough to change sentiment and could trigger the start of a meaningful pullback in the USD/JPY.

The best sign of a shift in sentiment would be a prolonged break under 4.00% by the U.S. 10-year Treasury note.

Watch the price action and order flow in the USD/JPY when the 10-year starts to trade at 4.00%. The Dollar/Yen could collapse if this level is taken out with conviction on heavy selling volume.