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James Hyerczyk

After showing early signs of topping due to flight-to-safety buying of the Japanese Yen on Friday, the Dollar/Yen recovered to close near its highs for the week. The Forex pair surged to 113.71, putting it slightly below the December 12 top at 113.745. The catalysts behind the rally were rising U.S. interest rates and solid U.S. economic data.

The USD/JPY settled on Friday at 113.685, up 0.279 or +0.25%.

Upside momentum is strong as demonstrated by Thursday and Friday’s quick recovery from a technical closing price reversal top on Wednesday. Not only is the rally being fueled by buy stops and short-covering, but aggressive investors have also showed that they are willing to buy strength now that the Fed has laid out its plans for further rate hikes. Given the Forex pair’s current position and the strength of the buying, it doesn’t look like it’s going to take much to drive prices to the top at 114.728 or the cluster of tops slightly above 115.000.

The price action is being primarily driven by the divergence in monetary policies between the hawkish U.S. Federal Reserve and the dovish Bank of Japan.

Earlier in the week, the U.S. Federal Reserve increased the target for the bank’s benchmark by 0.25%, to a range of 2%-2.25%. A majority of Federal Open Market Committee members also said they expect another rise before the end of the year. This was also the bank’s eighth rate hike since 2015, continuing its policy of gradual rate hikes.

FOMC members led by Chairman Jerome Powell said the economy is strong enough that aggressive stimulus is no longer necessary. This confidence was shown by the Fed ending its description of its policy as “accommodative”.

Powell also said the rate hike reflected the Fed’s confidence in the U.S. economy, describing it as a “particularly bright moment”.

Fed officials now expect the U.S. economy to grow by 3.1% this year, faster than the 2.8% forecast in March, according to the projections released after the meeting. Their predictions for inflation remained unchanged at around 2%.

The FOMC forecasts showed Fed officials expect about three rate hikes in 2019 and one more in 2020, which would lift the central bank’s important Fed funds rate to about 3.4% that year.

By comparison as revealed in Friday’s Bank of Japan Summary of Opinions, policy board members of the BOJ are becoming increasing concerned about downside risks to the economy and prices, including the potential impact of trade frictions.

“With regard to the risk balance in the global economy, there likely remain growing downside risks stemming from trade friction between such economies as the United States and China as well as from fluctuations in financial markets,” one of the BOJ’s nine policy board members said, according to the summary of the board’s meeting held on September 18-19.

The BOJ stood pat on policy at the September meeting after making a number of tweaks in July to prepare for a longer-than-expected fight to lift inflation, which has yet to reach the bank’s 2% target. It also reiterated that the bank will allow the 10-year Japanese government bond yield to move in a wider range in a bid to revive JGB trading.

The divergence in policies can’t be any clearer. This is why the USD/JPY is bullish.

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