USD/JPY Fundamental Daily Forecast – US-Japan Yield Spreads Dictating the Directon of Dollar/Yen

The Dollar/Yen strengthened on Friday as demand for riskier assets returned with the rally in U.S. Treasuries running out of steam and global stock markets improving.

Despite the slight recovery in the Forex pair, the Japanese Yen was still poised to finish higher for the week, having posted its biggest daily rise since November the previous session.

On Friday, the USD/JPY settled at 110.103, up 0.341 or +0.31%.

The USD/JPY has been under pressure since posting a technical reversal top on July 1 after touching its highest level since March of 2020. Traders picked up where they left off the previous week, hitting the Dollar/Yen hard as investors unwound bets on risky currencies and as concerns over the spread of COVID variants increased the demand for safe havens.

The greenback was weaker against the Japanese Yen and other currencies which are generally low-interest rate, stable markets that traders short, using the proceeds to buy riskier assets. However, with bond yields rising and equity markets tanking, riskier positions in currencies, like the U.S. Dollar, were sold off, benefiting the Japanese Yen, which is considered a safe-haven currency.

US Fed, Economic Reports Weigh on Dollar/Yen

Minutes of the U.S. Federal Reserve’s June policy meeting released on Wednesday showed that while the economic recovery “was generally seen as not having yet been met,” Fed officials agreed they should be poised to act as if inflation or other risks materialized.

In minutes that reflected a divided Fed wrestling with new inflation risks but still relatively high unemployment, “various participants” at the June 15-16 meeting felt conditions for reducing the central bank’s asset purchases would be “met somewhat earlier than they had anticipated.”

Others saw a less clear signal from incoming data and cautioned that reopening the economy after a pandemic left an unusual level of uncertainty which required a “patient” approach to any policy change, stated the minutes, which were released last Wednesday.

In economic news, data on Thursday showed the number of Americans filing new claims for unemployment benefits rose unexpectedly the week-ending July 2, an indication that the labor market recovery from the COVID-19 pandemic continues to be choppy.

Short-Term Outlook

The headlines are nice to read, but USD/JPY should be following the direction of Treasury yields this week, rather than the news. If you read the headlines last week, you would’ve seen that Japan said no spectators would be allowed at the Olympic Games later this month. The country also declared a state of emergency due to the spread of the COVID-19 variants.

This news on paper should have been bearish for the Japanese Yen because it likely meant more problems for the domestic economy, putting a long-term cap on any plans by the Bank of Japan to reduce stimulus. Meanwhile, the Fed appears to be moving toward tapering its bond purchases.

Instead of being bearish, the Japanese Yen rallied because investors aren’t following the news, they are tracking the spread between U.S. Government bond yields and Japanese Government bond yields.

A further tightening of the spread will pressure the USD/JPY, while a widening of the spread will be supportive for the greenback.