USD/JPY Fundamental Daily Forecast – Fed May Have to Deliver Major Surprise to Keep Upside Momentum Strong

The Dollar/Yen retreated from its highest level since January 24 on Tuesday as U.S. Treasury yields dipped and investors looked for fresh incentives to by the Greenback.

On Tuesday, the USD/JPY settled at 110.899, down 0.146 or -0.13%.

The Dollar/Yen’s recent rise has been driven by generally upbeat U.S. economic data that has kept the Federal Reserve on track to raise interest rates at least two more times this year. In contrast, other major central banks such as the Bank of Japan are widely expected to keep interest rates at historically low levels while offering no hints as to when they will start tightening.

The divergence in monetary policies between the Fed and the BOJ has essentially been the main driver of the price action.

There was no change in policy on Tuesday. Investors were probably paring positions ahead of Wednesday’s release of the Fed Monetary Policy Minutes from its May meeting.

There were no major economic releases on Tuesday. U.S. government debt yields were largely flat. The yield on the benchmark 10-year Treasury note, which moves inversely to price, was largely unchanged at 3.071 percent, while the yield on the 30-year Treasury bond was also stagnant at 3.214 percent.

Forecast

Early Wednesday, the Dollar/Yen is trading slightly lower in limited trading and on low volume. Later today, Japan will release a report on All Industries Activity. It is expected to come in at 0.1%, lower than the previously reported 0.4%.

At 0211 GMT, the USD/JPY is trading 110.499, down 0.400 or -0.36%.

Early in the U.S. session on Wednesday, investors will get the opportunity to react to the latest data on Flash Manufacturing PMI, Flash Services PMI and New Home Sales. Flash Manufacturing PMI is expected to come in at 56.6, up slightly from 56.5. Flash Services PMI is expected to come in at 54.9, up from 54.6. New Home Sales are expected to drop from 694K to 680K.

The main event will be the release of the Fed minutes at 1800 GMT. The minutes offer Dollar/Yen investors an idea of how the U.S. central bank is thinking about the strength of the economy, with many expecting that the Federal Open Market Committee will raise rates in June to stay ahead of creeping inflation.

Minutes from the previous meeting showed that “all participants” expected both the economy to strengthen and inflation to rise “in coming months,” citing strong spending patterns and a consistently tight labor market.

Traders will be watching the Fed minutes for the central bank’s opinion on inflationary pressures and the future path for interest rates.

Some traders believe the Fed minutes may contain information about what the Fed will do in 2019. Others are saying the Fed may have discussed current market developments, including the tightening in financial conditions, the strengthening of the dollar, and the flattening and, perhaps ultimately, inversion of the yield curve.

If the Fed continues increasing the federal funds rate and longer-term yields do not move higher, an inversion in the yield curve is possible. An inverted yield curve is when short-dated yields move above long-dated yields. An inversion is often called the best predictor of a recession.

Finally, Analysts will be looking for the minutes to clarify new language in the May policy statement, particularly the addition of the phrase the Fed officials expect inflation to run near the Committee’s “symmetric” 2% objective over the medium term.

Basically, the most important thing the Fed minutes could tell investors is how far officials will let inflation rise above their 2% target.

Look for the USD/JPY to continue to rally if hawkish Fed minutes drive U.S. Treasury yields to new multi-year highs. There is some concern that the market is expected the Fed to be hawkish so we may see a “buy the rumor, sell the fact situation.” If this is the case then the minutes are going to have to contain a major surprise to trigger a breakout to the upside. Otherwise, look for weakness if the Fed delivers what traders are expecting.