USD/JPY Fundamental Weekly Forecast – Volatility Expected as Investors Choose Between Risk-On and Risk-Off Scenarios

The Dollar/Yen closed lower last week, but volatility was relatively low and the price action tight as investors battled with each other over a rapidly changing fundamental picture.

Driving the bearish side of the equation was a plunge in Treasury yields and increased odds of a sooner-than-expected rate cut by the U.S. Federal Reserve. Concerns over U.S.-China trade relations also kept a lid on prices as well as the introduction of new U.S. tariffs on Mexico that were expected to kick in on June 10.

The bullish side of the equation was supported by increased demand for higher risk assets. U.S. stocks rose on the hope that the Fed would cut rates to stimulate the economy. This news kicked in the carry trade, whereby investors borrow from Japanese banks, sell Yen and buy dollars to invest in the U.S. stock market.

Last week, the USD/JPY settled at 108.203, down 0.088 or -0.08%.

Bearish Details

Keeping a lid on prices throughout the week were expectations of lower U.S. interest rates after Federal Reserve Chairman Jerome Powell said on June 4 the central bank is watching economic developments and will do what it must to keep the near-record expansion going.

On June 7, Treasury yields fell after the U.S. government said the economy added far fewer jobs than expected during the month of May. The 10-year Treasury yield dropped below 2.06%, its lowest since September 2017.

Market expectations for a Fed rate cut in June rose to 27.5% from 16.7% after the jobs data release, according to the CME Group’s FedWatch tool. The market is also pricing in a 79% chance of lower Fed rates by July.

Early in the week, President Trump threatened to impose tariffs on all Mexican goods, sending the stock market into volatile territory and causing the bond market to price in a lower rate environment.

Bullish Details

The major U.S. equity indexes posted solid gains last week as weak economic data increased the odds of easier monetary policy from the Federal Reserve.

Weekly Forecast

Last week’s price action suggests investors may be forming a support base. It also indicates that investors aren’t too worried about the Fed rate cut. Given the steep drop in Treasury yields since early May and the decline in the USD/JPY, it appears that investors have priced in a rate cut.

What they may have not priced in is the rally in the stock market. This could cause a short-covering rally this week.

The direction of the USD/JPY this week is will likely be determined by whether risk is on or risk is off. A risk on scenario will be supportive for the Dollar/Yen. Risk off is likely to keep a lid on prices and may even trigger an extension of the break.