USD/JPY Fundamental Weekly Forecast – Investors Making Adjustments to Heightened Volatility

Uncertainty over U.S.-China trade relations drove the price action last week in the Japanese Yen. It wasn’t the actual possibility that a potential trade deal would fall apart and the trade dispute between the economic powerhouses would escalate, but rather how these events would impact the U.S. economy.

Stock market volatility and weakness played a role in the movement in the Japanese Yen as many equity investors sought shelter in the so-called safe-haven asset. However, a lot of investors also bet heavily that a prolonged trade dispute would weaken the U.S. economy enough to cause a recession later in the year.

A U.S. recession would force the Federal Reserve to lower interest rates. So some of the price action we saw last week was attributed to investors making moves in anticipation of a shift in Fed policy later in the year.

The biggest driver of the longer-term direction of the Dollar/Yen has been the divergence between the monetary policies of the comparatively hawkish U.S. Federal Reserve and the ultra-dovish Japanese Yen. With both central banks holding their benchmark rates steady, the interest rate differential has remained basically the same for a while.

So when market conditions change and the threat of a policy shift exists, investors are forced to make changes to their portfolios. In this case, there is no U.S. recession at this time, but conditions could shift later in the year if the U.S.-China trade disputes escalates to that point. Last week’s drop in U.S. Treasury yields reflected this concern, dragging down the USD/JPY.

This week, the U.S. and Japanese economic schedules are light as far as major economic releases are concerned. The U.S. is scheduled to release data on retail sales on Wednesday. This report is an important component of Fed policy because it involves the consumer and the consumer ultimately drives the economy. However, this report is likely to continue to take a backseat to U.S.-China trade relations.

Further weakness and volatility in the global equity markets will likely put pressure on global interest rates and this will help increase the Japanese Yen’s appeal as a safe-haven asset. If conditions calm and stocks start to recover then look for the USD/JPY to start to recover some of last week’s losses.