USD/JPY Fundamental Weekly Forecast – Investors Caught Between Potentially Dovish Fed, Increased Risk Appetite

Although dovish changes in Fed policy could drive the USD/JPY lower, a steep rise in U.S. equities could drive investors back into the dollar because of the carry trade. We’re bearish the Dollar/Yen because of the potential impact of the Fed news, but will be looking to reverse if demand for risk jumps.
James Hyerczyk
USD/JPY

The Dollar/Yen closed lower after spending most of the week trading positive. The price action was mostly two-sided with the Forex pair attracting support from concerns over a weakening global economy and a dovish Bank of Japan. Putting a lid on the strength and turning the Forex pair lower late in the week was a report calling for a dovish policy move by the Fed at this week’s central bank meeting.

Last week, the USD/JPY settled at 109.545, down 0.229 or -0.21%.

The Dollar/Yen was supported early in the week after China announced that its official economic growth came in at 6.6 percent in 2018, the slowest pace since 1990. Fourth-quarter GDP growth was 6.4 percent, a sign the economy is decelerating.

Shortly thereafter, an announcement from the International Monetary Fund (IMF) further support the Forex pair when it cut its global growth forecast for 2019 to 3.5 percent from 3.7 percent. Speaking at the World Economic Forum in Davos, Switzerland, IMF Managing Director Christine Lagarde said the move was due to the high level of economic risks that are accelerating around the globe. These include the U.S-China trade war, Brexit and China’s slowing economy.

The Dollar/Yen was further supported after the Bank of Japan cut its inflation forecasts but maintained its massive stimulus program. Governor Haruhiko Kuroda also warned of growing risks to the economy from trade protectionism and faltering global demand.

“To be honest, if U.S.-China trade tensions are drawn out, there will be a serious risk to the global economy first to the two countries own economies,” Kuroda told a news conference after the end of the two-day policy review. “For now, that possibility is slim, and I hope they will resolve this soon.”

The USD/JPY was supported until Friday when The Wall Street Journal reported U.S. Federal Reserve officials are nearing a decision on when to end its balance sheet reduction program.

Forecast

The major news events are in the United States this week.

On Wednesday, January 30, the Fed will release its interest rate decision and monetary policy statement. This will be followed by a press conference.

The Fed is widely expected to leave its benchmark interest rate unchanged. Additionally, it may announce it is considering ending its policy to reduce its balance sheet. Both moves are dovish because they point towards an easing of monetary policy. This could drive Treasury yields lower, making the U.S. Dollar a less-attractive investment.

On Friday, traders will be watching the U.S. Non-Farm Payrolls report. It is expected to show the economy added 165K jobs in January. The unemployment rate could drop to 3.8% and Average Hourly Earnings are expected to come in at 0.3%.

Additional reports are Conference Board Consumer Confidence and ISM Manufacturing PMI.

The wildcard is the impact of the opening of the government and the start of high level trade talks between U.S. and Chinese officials on January 30-31.

Although dovish changes in Fed policy could drive the USD/JPY lower, a steep rise in U.S. equities could drive investors back into the dollar because of the carry trade. We’re bearish the Dollar/Yen because of the potential impact of the Fed news, but will be looking to reverse if demand for risk jumps.

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