USD/JPY Fundamental Weekly Forecast – Direction Hingeing on Reaction to Trade Dispute, Fed Rate Projections

The Dollar/Yen rose sharply last week as investors exited safe-haven long positions in the Japanese Yen as fear of an escalation of the trade war between the United States and China fell following the latest round of tariffs announced last Monday and Tuesday.

The “risk on” mood came about as optimism towards U.S.-China trade issues cleared the path for the dollar’s rise.

The USD/JPY settled at 112.548, up 0.476 or +0.42%.

Higher U.S. yields, particularly the two-year yield’s rise, added further momentum to the dollar’s gains versus the yen ahead of next week’s Fed meeting. The two-year Treasury yield climbed to a record high last week on the back of receding risk aversion and expectations for a hawkish Federal Reserve meeting this week.

Also last week, the Bank of Japan (BOJ) reiterated last Wednesday that it would keep interest rates extremely low “for an extended period,” holding to forward guidance it first introduced in July.

The central bank decided to stand pat on policy after making a number of tweaks in July to prepare for a longer-than-expected fight to lift inflation, which has yet to reach the central bank’s 2% target.

Forecast

It’s a tough call because we’re dealing with sentiment and not an absolute, but we could be looking at a risk-off trade this week if investors perceive the cancellation of trade talks between the United States and China as an escalation of the trade dispute between the two economic powerhouses. This could drive money into the safe-haven Japanese Yen.

Bullish traders may say that all the Chinese did is postpone the meeting until after the November U.S. mid-term elections. So there is no need to worry.

Also contributing to the movement in the Dollar/Yen will be the outcome of this week’s two-day Federal Open Market Committee meeting which culminates with the Fed’s interest rate and monetary policy decision on Wednesday, September 26.

Although the Fed is widely expected to raise its benchmark interest rate during the meeting, Japanese Yen traders will be primarily focused on the direction the Fed will chart ahead. Traders essentially want to know how aggressive the Fed will be in increasing rates in the future.

The 25-basis point increase to the federal funds rate is already priced into the market. The hike will push the funds target to 2 percent to 2.25 percent, where it last was more than 10 years ago.

Since the rate hike has already been factored into the Dollar/Yen, traders will be paying more attention to any information that shows how much more monetary tightening will be necessary to keep the economy (and inflation) healthy.

The USD/JPY could be pressured if the Fed appears to be too “dovish” in its assessment of the need for additional rate hikes. In other words if it drops the word “accommodative” from its monetary policy statement. This would force investors to make adjustments to their bond portfolios due to a potential shift in the interest rate differential between U.S. Government bonds and Japanese Government bonds.

Also in the U.S., traders will get the opportunity to react to the latest data on consumer confidence, durable goods and gross domestic product.

In Japan, Bank of Japan Kuroda is scheduled to speak early Wednesday.