USD/JPY Fundamental Daily Forecast – Showing Limited Reaction to Fed’s Telegraphed Decisions

The Dollar/Yen is inching higher on Thursday, but trading inside yesterday’s range which suggests investor indecision and impending volatility. The limited price action is being fueled as investors continued to digest the Fed’s latest policy decision.

Overnight, the yield on the benchmark 10-year Treasury note fell less than a basis point to 1.4582%, and the yield on the 30-year Treasury bond rose by less than a basis point to 1.8627%.

The price action suggests the Fed’s hawkish tone had been fully-priced into the Dollar/Yen, giving investors little room to rally the Forex pair. Furthermore, the market is primarily driven by the spread between U.S. Government bond yields and Japanese Government bond yields. With yields dipping, the spread tightened, making the dollar a less-desirable investment.

Over the long-run, we could see further upside action, but it’s not likely to occur unless Treasury yields make another run at recent highs. We could see this as the economy strengthens and as the Fed begins to aggressively reduce stimulus.

At 09:45 GMT, the USD/JPY is trading 114.110, up 0.056 or +0.05%. On Wednesday, the Invesco CurrencyShares Japanese Yen Trust ETF (FXY) settled at $82.26, down $0.28 or -0.34%.

Federal Reserve Recap

Following its two-day policy meeting, the Fed announced Wednesday that it would be buying $60 billion of bonds a month starting in January. This is half the level it bought prior to the November taper and $30 billion less than in December.

The Fed was tapering by $15 billion a month in November, doubled that in December, and will accelerate the reduction further come 2022.

This would see the central bank wrap up its tapering program by late winter or early spring.

Fed officials expected as many as three rate hikes in 2022, according to the central bank projections released on Wednesday.

Fed’s Powell:  Economy No Longer Needs Increasing Support from Asset Purchases

Federal Reserve Chair Jerome Powell on Wednesday said the U.S. economy is improving quickly and no longer needs the “increasing support” provided by its asset purchases, making it appropriate to conclude that program earlier than previously projected.

“The economy no longer needs increasing amounts of policy support,” he said.

Powell also added that the pace of inflation is uncomfortably high, and “in my view, we are making rapid progress toward maximum employment,” a combination of circumstances that has now convinced all Fed officials, even the most dovish, that it is time to exit more fully the pandemic policies put in place two years ago.

Daily Outlook

The early price action indicates USD/JPY investors are content with the Fed’s decisions on Wednesday, and may be willing to wait to see how they evolve. Like I said earlier, we’re not likely to see a surge in the Forex pair unless Treasury yields move substantially higher. However, the Fed doesn’t want to see a spike in interest rates. If they did, they would’ve announced a more aggressive tapering.

They prefer a gradual tightening. If they moved faster I think they would be erode investor confidence by suggesting inflation was getting out of control.

Furthermore, let’s call the Fed decisions Part 1 of the tightening process. Policymakers are going to cut stimulus and raise rates, but to truly take the training wheels off the economy, the Fed would have to start shrinking its balance sheet by selling back the government bonds they have been buying since the pandemic began in March 2020.

Powell said on Wednesday, they have made no decision yet on whether to start reducing the central bank’s balance sheet.