USD/JPY Fundamental Daily Forecast – Supported by Rising U.S. Interest Rates

The Dollar/Yen continues to strengthen on the back of rising U.S. Treasury yields. The widening of the interest rate differential between U.S. Government bonds and Japanese Government bonds is making the U.S. Dollar a more attractive investment.

Perhaps limiting gains is some light safe-haven buying of the Japanese Yen due to renewed concerns over the trade dispute between the United States and China. Early in the session on Monday, this news pressured the Dollar/Yen, but eventually traders shrugged it off and the Forex pair rallied into the close.

There was also an early reaction to a sell-off in U.S. equity markets due to political turmoil in Washington, but this was also quickly overcome as investors shifted their focus back to interest rates.

Looking ahead, the Federal Open Market Committee’s (FOMC) meeting is due to take place on Tuesday and Wednesday. Fed Chairman Jerome Powell will likely discuss the strengthening economy, competitive labor market and burgeoning inflation at a news conference afterwards.

The Fed is also widely expected to bump interest rates higher by a quarter-point. However, this has already been factored into investor forecasts. The rate hike will push the funds target to 2 percent to 2.25 percent, where it was last more than 10 years ago.

BOJ Minutes

According to Reuters, a few Bank of Japan (BOJ) board members said the central bank must consider more seriously the potential dangers of ultra-easy policy, such as the negative impact on the country’s banking system, minutes of their policy meeting in July showed on Tuesday.

Some in the nine-member board also worried whether the BOJ could trigger a spike in long-term interest rates by allowing bond yields to move more flexibly around its zero percent budget.

The debate yet again reinforced the challenges the central bank faces as stubbornly weak inflation forces it to maintain a massive stimulus program despite the rising costs, such as the hit to bank profits from prolonged ultra-low rates.

Financial intermediation problems generally point to how ultra-low rates hurt commercial banks’ profits and discourage them from lending, thereby eroding the positive effect of monetary easing.

Another member said the BOJ should look more carefully at how its monetary policy was affecting Japan’s banking system, the minutes showed.

Two board members dissented, arguing that the changes would make the BOJ’s policy commitment ambiguous and raise doubts in the market over its commitment to achieve its elusive 2 percent inflation target.

Finally, a few members cautioned that the BOJ, by mentioning in its statement that bond yields could move up or down depending on market conditions, could trigger “unnecessary” rises in yields or risk being misinterpreted by markets as paving the way for future rate hikes, the minutes showed.

Forecast

The USD/JPY is likely to remain underpinned as long as the focus for investors remains on the widening of the spread between U.S. Government bond yields and Japanese Government bond yields. Also helping to drive the Forex pair higher is the divergence between the monetary policy of the hawkish U.S. Federal Reserve and the dovish Bank of Japan.

Gains could be limited, or the USD/JPY could be pressured by increased demand for the safe-haven Japanese Yen. The catalysts behind any weakness are likely to be an escalation of the trade dispute between the United States and China, and political turmoil in the White House.