USD/JPY Fundamental Weekly Forecast – Investors Not Conviced Faster Tapering Means Faster Rate Hikes

The Dollar/Yen put in a mixed performance last week before closing higher. The price action was mostly fueled by volatile movement in Treasury yields as a result of a hawkish decision by the Federal Reserve last Wednesday. The Bank of Japan also released its monetary policy decisions, which offered no surprises.

Last week, the USD/JPY settled at 113.715, up 0.323 or +0.28%. The Invesco CurrencyShares Japanese Yen Trust ETF (FXY) finished at $82.54, down $0.21 or -0.25%.

Throughout the week, the market was rejected inside the short-term retracement zone at 114.029 to 114.380, but it also found support on the top of a long-term retracement zone at 113.173 to 112.619.

The near-term range can best be described as 114.380 to 112.169. The upper level is a potential trigger point for an acceleration to the upside with 115.519 the next major target. The lower level at 112.619 is a potential trigger point for an acceleration to the downside with 110.826 the next potential target.

Fed Will Aggressively Dial Bank Its Bond Buying, Sees Three Rate Hikes Next Year

The Federal Reserve provided multiple indications last Wednesday that its run of ultra-easy policy since the beginning of the Covid pandemic is coming to a close, making aggressive policy moves in response to rising inflation.

For one, the central bank said it will accelerate the reduction of its monthly bond purchases.

The Fed will be buying $60 billion of bonds each month starting in January, half the level prior to the November taper and $30 billion less than it had been buying in December. The Fed was tapering by $15 billion a month in November, doubled that in December, then will accelerate the reduction further come 2022.

After that wraps up, in late winter or early spring, the central bank expects to start raising interest rates, which were held steady at last week’s meeting.

Projections released Wednesday indicate that Fed officials see as many as three rate hikes coming in 2022, with two in the following year and two more in 2024.

BOJ Dials Back Pandemic Funding as Global Central Banks Eye Post-COVID Era

The Bank of Japan last Friday dialed back emergency pandemic funding but maintained ultra-loose policy and extended financial relief for small firms, cementing expectations it will remain among the most dovish central banks for the foreseeable future.

BOJ Governor Haruhiko Kuroda said borrowing costs will remain low in Japan even as other central banks hike interest rates, stressing the roll-back of emergency funding was in no way a prelude to a full-blown withdrawal of monetary stimulus.

Also, in a widely expected decision, the BOJ maintained its short-term rate target at -0.1% and that for 10-year bond yields around 0%.

Weekly Outlook

Traders are asking if the U.S. Federal Reserve was hawkish and the Bank of Japan was dovish then why didn’t the USD/JPY breakout to the upside?

The easy answer is the news was already priced into the Dollar/Yen. The complicated answer can be found in studying the U.S. Treasury yield curve.

The initial reaction by the USD/JPY to the Fed news was bullish. And why not? Policymakers had announced a faster tapering and three, not two rate hikes in 2022. The news of the quicker pace of tapering was interpreted to mean the Fed could raise rates as early as April.

However, traders now interpret it to mean the Fed will have a lot more time to decide when to raise rates three times in 2022. This is causing investors to make adjustments to their portfolios to reflect a slower pace of rate hikes, which is weighing on the Dollar/Yen.

Moving forward just remember this:  Faster Tapering, Faster Rate Hikes will be bullish for the USD/JPY. Faster Tapering and Slower Rate Hikes will put a little pressure on the Dollar/Yen, but I wouldn’t call it bearish.