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USD/JPY Fundamental Weekly Forecast – Traders Reacting More to Treasury Yields Than Stock Market

By:
James Hyerczyk
Published: Jul 8, 2018, 18:48 UTC

Here is the takeaway, keep an eye on the yield curve. The fear is that the flattening yield curve could invert, meaning that short-term rates would exceed longer-term yields. This action is typically viewed as a recession signal. This would be bearish for the USD/JPY.

Japanese Yen, USD/JPY

The Dollar/Yen closed lower last week in reaction to concerns over a fourth rate hike by the U.S. Federal Reserve and safe-haven buying due to the escalation of the trade dispute between the United States and China. Both factors contributed to lower Treasury yields which made the U.S. Dollar a less-attractive asset.

The USD/JPY settled at 110.484, down 0.203 or -0.18%.

On Friday, the U.S. Labor Department said the economy created more jobs than expected in June, but the closely watched inflation gauge – Average Hourly Earnings – rose less than forecast and the unemployment rate increased.

As a result, expectations of a fourth rate hike later this year declined. According to the Fed Funds Indicator, investors priced in a 77 percent chance of a September rate hike, down from 80 percent before the jobs data.

So while a September rate hike is still a likely event, traders feel that without an acceleration of wage growth, a fourth hike at the end of the year is a more difficult call and the futures market shows that traders are putting the odds of a December rate hike at about 50 percent.

Also on Friday, U.S. tariffs on $34 billion of Chinese goods came into effect. China responded to the fresh tariffs by imposing its own retaliatory levies on imports from the United States.

In other news last week, investors responded positively to the ISM Manufacturing PMI report which came in better-than-expected at 60.2 versus 58.2. Sandwiched between the manufacturing report and the jobs data was the minutes from the Federal Open Market Committee’s June Meeting. The minutes reflected confidence among the Federal Reserve’s policymakers in the strength of the U.S. economy and its plans for future interest rate hikes.

Forecast

Last week’s price action served as proof that USD/JPY investors were locked in on the direction of U.S. Treasury yields rather than the rally in the U.S. equity markets. Usually when stocks rally, it takes the Dollar/Yen with it because of the carry trade. However, investors were reacting to the lower Treasury yields instead. And this could mean something is happening in the economy that is making Dollar/Yen bulls a little nervous.

Although the performance in the U.S. equity markets suggests investors are not too concerned about escalating trade tensions between the United States and its major trading partners in China and the European Union, the price action in the Treasury markets indicates investors are being cautious and taking some protection against a possible economic downturn.

Last week, the yield curve, a set of interest rates watched closely by bond market professionals, has gotten to its flattest level since before the financial crisis. The spread between 2-year note yields and 10-year yields is around 30 basis points, down from about 90 basis points one year ago.

About the Author

James is a Florida-based technical analyst, market researcher, educator and trader with 35+ years of experience. He is an expert in the area of patterns, price and time analysis as it applies to futures, Forex, and stocks.

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