USD/JPY Fundamental Daily Forecast – Yields, Demand for Risk Driving Price Action, Not Trade War Headlines

The Dollar/Yen is trading higher for a second day early Tuesday. Contrary to what you may see in the headlines, investors aren’t worried about a trade war at this time. I’m not saying it’s not going to happen at some point in the future, but if you look at the price action in the financial markets, there is no evidence that trade war concerns are rattling investors.

At 0600 GMT, the USD/JPY is trading 109.893, up 0.073 or +0.07%.

In my opinion, if investors were worried about a trade war, we wouldn’t be seeing the strong appetite for risky assets that is driving up U.S. stocks, Treasury Yields, commodity-linked currencies and the USD/JPY.

I’ve mentioned several times over the years that the movement in the USD/JPY about 95% of the time is driven by U.S. Treasury yields and demand for risky assets. Given the dovish Bank of Japan monetary policy and the hawkish U.S. Federal Reserve monetary policy, the USD/JPY will continue to rise if the spread between U.S. Government bonds and Japanese Government bonds continues to widen. It can only widen if U.S. Treasury yields increase faster than JGB yields.

Furthermore, when there is appetite for risk, investors will turn to the carry trade to increase their leverage in the asset they are buying. To do this, they borrow from Japanese banks at extremely low rates and invest in U.S. equities. Once they get the money from the Japanese banks, they sell Japanese Yen and buy U.S. Dollars.

Look at the price action again on Monday and you’ll see this strategy in motion. The direction of Treasury yields should be your primary guide when trading the USD/JPY.

When unexpected news hits the financial markets like an actual trade war, the surprise will create uncertainty. Investors will then shed their risky assets and place the profits in lower-risk assets like U.S. Treasury yields, gold and the Japanese Yen.

When there is risk in the market, chances are some investors aren’t actually going long the Japanese Yen, speculators are doing so, however. When investors holding risky assets decide it’s time to book some profits, or reduce long positions, they sell their stocks. Then they take some of the dollars from the proceeds and pay back their loans from Japanese banks. In doing so, they sell dollars and buy Japanese Yen.

At the same time, if investors buy U.S. Treasury bonds for safety, they essentially are driving down yields because of their inverse relationship. When yields fall, the U.S. Dollar becomes a less-desirable investment.

Given the current investment environment of rising U.S. Treasury yields and increased appetite for risky assets like stocks, look for a stronger USD/JPY. Investors may be worried about a trade war, but until it is reflected in U.S. Treasury yields or the stock market, it’s just a distraction or noise. So stop reading the headlines and read the price action and the order flow. You’ll have time to make an adjustment when there is actually a trade war taking place.

What are you supposed do if there are worries in the market? Not trade. I’m not sure what these headlines are saying. Every professional trader and investor knows the primary price drivers and make adjustments when there are surprises. Try to adapt this strategy instead of reacting to headlines.