USD/JPY Fundamental Weekly Forecast – Yuan, Global Bond Yields Controlling Price Action

The Dollar/Yen finished sharply lower last week as escalating tensions between the United States and China encouraged investors to seek shelter in the lower-yielding Japanese Yen. Some of the selling was fueled by a steep drop in global equity markets, but that selling dissipated throughout the week as stocks mounted a strong enough comeback to finish nearly unchanged for the week. Most of the selling in the Dollar/Yen was driven by a plunge in global bond yields that raised concerns over a global recession.

Last week, the USD/JPY settled at 105.690, down 0.914 or -0.86%.

Plummeting Yields Driving the Price Action

The yield on the benchmark 10-year U.S. Treasury note fell to a three-year low last week and the 30-year Treasury bond rate also neared an all-time low. Fresh concerns about an economic slowdown, a protracted trade dispute between the world’s two largest economies and muted inflation fueled investor appetite for U.S. Treasurys and the Japanese Yen.

China Retaliates

Last week’s price action was primarily driven by China’s response to President Trump’s announcement of additional tariffs on August 1. China retaliated by canceling all plans to buy American agricultural products and allowing its currency to dip below the key 7 yuan to 1 U.S. Dollar level. The U.S. then declared China a currency manipulator.

Weekly Forecast

Dollar/Yen traders will continue to focus on the direction of U.S. Treasury yields this week. Traders have already priced in a 25-basis point rate cut by the Federal Reserve in September. I don’t expect this to change, but there is still some debate over whether the Fed will cut 50-basis points. Last week, the Reserve Bank of New Zealand opened the door to this possibility.

The market turmoil caused by the escalation of tensions between the U.S. and China should be enough for the quarter-point rate cut. Weak economic data could be the factor that drives it to cut half a point.

On Friday, the government reported that producer prices increased at a sluggish pace on July. The Labor Department said its producer price index rose 0.2% last week after inching just 0.1% higher in June. Excluding volatile food and energy components, producer prices fell 0.1% in July, the first such decline since October 2015.

The Fed has a 2% inflation target, but favors the core personal consumption expenditures (PCE) as an inflation gauge. The core PCE price index increased 1.6% on a year-on-year basis in June and has undershot its target this year.

This week, investors will be focused on U.S. consumer inflation data. CPI is expected to have risen 0.3% and Core CPI is expected to have risen 0.2%.

Core Retail Sales are expected to come in at 0.4% and Retail Sales at 0.3%.