USD/JPY Fundamental Weekly Forecast – Bullish Outlook for Dollar/Yen if Fed Fund Projections are Correct

The Dollar/Yen is trading nearly flat early Tuesday as investors prepare for the start of the Federal Reserve two-day policy meeting. Most of the major players have probably taken to the sidelines ahead of Wednesday’s major policy announcements that could set the tone in the market for the next several months.

At 0:16 GMT, the USD/JPY is trading 114.039, up 0.043 or +0.04%.

Traders Expect an Aggressive Fed

The Federal Reserve on Wednesday is expected to approve plans to scale back its $120 billion monthly bond-buying program put in place to help the economy during the coronavirus pandemic, while investors will also be focused on commentary about interest rates and how sustained the recent surge in inflation is.

Investors on Monday continued to increase their expectations that high and persistent inflation would force the Fed to raise interest rates sooner and faster than policymakers have projected. Contracts in Federal Funds futures now imply three quarter-point rate increases next year, versus two as of late last week, according to data from the CME Group’s FedWatch.

Goldman Sachs has brought forward its forecast by a year to July 2022 for the first post-pandemic U.S. interest rate hike, as the investment bank expects inflation to remain elevated.

“The main reason for the change in our liftoff call is that we now expect core PCE inflation to remain above 3% – and core CPI inflation above 4% – when the taper concludes,” Goldman’s chief economist, Jan Hatzius, wrote in a client note.

Goldman Sachs also expects a second interest rate hike in November 2022 and two rate increases each year after that.

Bank of Japan Remains an Outlier Central Bank

Last Thursday, as expected, the Bank of Japan (BOJ) maintained its target for short-term interest rates at -0.1% and that for 10-year bond yields around 0%.

In fresh quarterly estimates, the BOJ cut its consumer inflation forecast for the year ending in March 2022 to 0% from 0.6%. It also slashed this year’s economic growth forecast on sluggish consumption and the hit to factory output from supply disruptions caused by the COVID-19 pandemic.

The projections highlight the policy gap between Japan and other economies.

Short-Term Outlook

The outlook couldn’t be simpler. Hawkish Fed/Dovish BOJ puts the advantage squarely on the Dollar/Yen. However, this doesn’t seem to bother BOJ Governor Haruhiko Kuroda.

Kuroda last Thursday welcomed the economic benefits of a weak yen, brushing off fears that rising import costs could derail a recovery and committing to an easy policy even as other nations dial back crisis-mode stimulus.

If the Fed signals three rate hikes in 2022 then we could see the USD/JPY at 115.50 or better rather quickly.