USD/JPY Fundamental Weekly Forecast – Spread between U.S. Treasuries/JGB’s Will Determine Direction

The Dollar/Yen started the week in a bullish position based on the previous week’s close. The widening spread between U.S. Government bonds and Japanese Government bonds (JGBs) was the catalyst behind the rally. Investors were betting big on the Fed continuing to tighten monetary policy and the Bank of Japan continuing their loose monetary policy.

The USD/JPY finished the week at 112.513, down 1.384 or -1.22%.

The USD/JPY inched higher on Monday and Tuesday, taking out the May 10 top at 114,367, but the rally stalled at 114.492 after the Forex pair reached its highest level since March 15. Also providing resistance was a key technical level at 114.633.

After posting a bearish technical closing price reversal top on the daily chart, the market proceeded to sell off into 112.250 before settling at 112.513.

The sell-off in the USD/JPY was fueled by three events:  Uncertainty around President Trump son’s involvement with Russia, unsettling remarks about the future of interest rates by the Fed Chair and disappointing U.S. economic data.

The selling actually started on Tuesday after President Donald Trump’s eldest son released an email chain citing Russian support for his father before last year’s U.S. election.

The situation with Trump’s son highlighted the dysfunction in Washington and the Trump administration’s inability to pass any meaningful legislation, particularly healthcare reform, tax reform and increased infrastructure spending. The selling of the dollar likely represents a loss of confidence in Trump’s ability to grow the economy.

The second wave of selling against the dollar occurred on Wednesday after Federal Reserve Chair said interest rate hikes would be gradual and that the U.S. central bank may not be able to raise rates by “all that much.”

She also said the U.S. economy remains strong enough for the Fed to continue its plans to gradually tighten policy, but shook up the financial markets when she raised concerns over the relatively low inflation. Her statement came at a time when the dovish Fed board members started talking about possibly stalling the tightening process until inflation is closer to target.

The dollar was hit for a third time on Friday following the release of weaker than expected U.S. economic data. U.S. government data showed consumer inflation was unchanged in June and retail sales fell for a second straight month. This news raised doubts about U.S. economic growth and whether the Federal Reserve would raise interest rates again in 2017.

Forecast

The direction of the USD/JPY this week will continue to be determined by the direction of the spread between U.S. Treasury yields and Japanese Government Bond yields. If the spread continues to tighten then look for the Dollar/Yen to weaken. A widening of the spread will be supportive for the Dollar/Yen.

Losses could be limited because of the carry trade, however. If demand continues to increase for higher-yielding assets then investors will sell Japanese Yen to finance the buying of U.S. stocks.

Traders will also get the opportunity to react to the latest Monetary Policy Statement and interest rate decision by the Bank of Japan. It is widely expected to leave interest rates unchanged at -0.10%.

The BOJ will also issue its Outlook Report and hold a press conference.

In the U.S., the major report will be on Housing Starts.

The primary downside objective is 111.640 to 110.967.