USD/JPY Fundamental Daily Forecast – Drop in Treasury Yields Makes 112.950 Next Major Target

The Dollar/Yen fell on Tuesday despite a bullish U.S. Producer Inflation report. The catalysts behind the sell-off were concerns over U.S. tax reform, lower Treasury yields and a drop in demand for higher risk assets. The strength in U.S. producer inflation wasn’t important to investors because the market has already priced in a rate hike. Investors are more concerned about future rate hikes given the problems getting tax reform passed into law.

The USD/JPY settled at 113.443, down 0.176 or -0.15%.

U.S. producer inflation rose more than expected in October, boosted by a surge in the cost of services, leading to the biggest annual increase in wholesale inflation in over 5 ½ years.

According to the Labor Department, the Producer Price Index for final demand increased 0.4 percent last month after a similar gain in September. In the 12 months through October, the PPI jumped 2.8 percent, the largest increase since February 2002.

The PPI rose 2.6 percent year-on-year in September. Economists had forecast the PPI edging up to 0.1 percent last month and increasing 2.4 percent from a year ago.

Additionally, the high yield debt market was under pressure, as buyers moved into the safety at the long end of the Treasury curve. Traders blamed the volatility in the bond and stock markets on concerns that tax reform may not make its way through Congress successfully. The nagging issue for investors is the flattening of the yield curve. Traders fear that an inversion of the yield curve will signal that a recession is on the horizon.

Forecast

Earlier today, investors had the opportunity to react to fresh economic news from Japan. Quarterly Preliminary GDP rose 0.3%, coming in below the 0.4% estimate. The previous number was revised down to 0.6%.

Revised Industrial Production was -1.0%, slightly better than the -1.1% estimate.

Traders weren’t too concerned that the GDP figure missed the estimate. This is because the rise still marked the longest period of uninterrupted growth in more than a decade, showing strong fundamentals.

The economy expanded at a 1.4 percent annualized rate in July-September on strong exports and slightly above the median estimate for annualized growth of 1.3 percent. That followed revised annualized growth of 2.6 percent in April-June.

There are two key reports from the U.S. to watch on Wednesday, consumer inflation and retail sales.

The U.S. Consumer Price Index is expected to come in up 0.1%. The Core CPI is expected to show a rise of 0.2%. Core Retail Sales are expected to show an increase of 0.2% and Retail Sales are expected to show no gain.

Despite the CPI reports, investors are likely to remain focused on the direction of Treasury yields and demand for higher-yielding assets. Another drop in yields and a sell-off in equities could drive the USD/JPY through key support at 112.950. This could trigger an acceleration to the downside with the next major target coming in at 111.646.