USD/JPY Fundamental Daily Forecast – More Aggressive Fed Tightening Cycle Will Support Dollar/Yen

The Dollar/Yen is edging higher early Thursday as the Forex pair attempts to rebound from yesterday’s setback. The Dollar rose against the Japanese Yen to its highest level in nearly three years on Wednesday as investors increased expectations for quicker Federal Reserve interest rate hikes ahead of the release of the Fed monetary policy minutes.

However, the Dollar/Yen pulled back after the minutes of the Federal Open Market Committee’s September meeting confirmed tapering of stimulus is all but certain to start this year, but failed to convince traders of the possibility of more rapid interest rate hikes. Nonetheless, the minutes did show a growing number of policymakers worried that high inflation could persist.

Essentially, the price action – higher-high, lower-close – suggests a “buy the rumor, sell the fact” situation. Speculators ran up the Dollar/Yen in anticipation of a tapering announcement, and sold the Forex pair when the Fed minutes confirmed their assessment.

At 05:11 GMT, the USD/JPY is trading 113.566, up 0.312 or +0.28%.

The USD/JPY also fell as the spread between U.S. Government bonds and Japan Government bonds tightened, making the U.S. Dollar a less-attractive investment. The 10-year Treasury yield fell after the release of stronger-than-expected inflation data, and the Fed minutes.

Treasury Yield Dip Weighs on Dollar/Yen

U.S. Treasury yields dipped on Wednesday as investors digested September inflation data and insights into the Federal Reserve’s tapering plans.

The yield on the benchmark 10-year Treasury note moved 3.8 basis points lower to 1.542%. The yield on the 30-year Treasury bond fell by 6.8 basis points to 2.037%.

Consumer Inflation Rises More than Expected

Consumer prices increased slightly more than expected in September with the consumer price index for all items rising 0.4% for the month, compared to the 0.3% Dow Jones estimate, the Labor Department reported Wednesday. On a year-over-year basis, prices increased 5.4% vs the estimate for 5.3%.

However, excluding volatile food and energy prices, the CPI increased 0.2% on the month and 4% year over year, against respective estimates for 0.3% and 4%.

“The print reflected that while transitory factors continue to roll-off, stickier more persistent factors are becoming more prevalent, which the Fed is more likely to respond to,” Bank of America analysts said in a note.

Fed Lays Out Plan to Reduce Bond Purchases, Flags Inflation Worries

The Federal Reserve signaled on Wednesday it could start reducing its crisis-era support for the U.S. economy by the middle of next month, with a growing number of its policymakers worried that high inflation could persist longer than previously thought.

Though no decision on a “taper” of the U.S. central bank’s $120 billion in monthly asset purchases was reached at its September 21-22 policy meeting, “participants generally assessed that, provided that the economic recovery remained broadly on track, a gradual tapering process that concluded around the middle of next year would likely be appropriate,” according to the minutes of that meeting.

Daily Forecast

With the wind-down in asset purchases imminent, USD/JPY trader attention now shifts to the timing of future interest rate hikes.

In the minutes, “various” policymakers thought that economic conditions would likely justify keeping rates near their current level for “the next couple of years.” A “number,” however, felt rates would need to rise by the end of next year because they felt it would have reached full employment; “some” also thought inflation would remain elevated with risks to the upside, the minutes showed.

At the end of trading on Wednesday, U.S. money markets were pricing about 50/50 odds of a first 25 basis point rate hike by July.

The faster and the more frequent the Fed raises rates, the higher the USD/JPY is likely to rise since the Bank of Japan has anchored its benchmark rate at below 0%.