USD/JPY Fundamental Daily Forecast – Favorable Interest Rate Differential Providing Support

The Dollar/Yen closed higher on Tuesday with the rally fueled by talk of higher interest rate in the Euro Zone and the United States.

The USD/JPY settled at 112.341, up 0.484 or +0.43%.

Tuesday’s rally was triggered initially by hawkish comments from European Central Bank President Mario Draghi. It was further supported later in the session by upbeat U.S. economic news and hawkish remarks by Federal Open Market Committee Member Patrick Harker.

Dollar/Yen traders also reacted to the widening of the interest rate differential between U.S. Treasury Bonds and Japanese Government Bonds. U.S. Treasury yields rose on Tuesday, following their European counterparts, as ECB President Draghi raised the possibility of monetary policy changes.

The yield on the benchmark 10-year Treasury note close near 2.2 percent, while the yield on the 30-year Treasury bond was up a 2.745 percent.

Early in the session, Treasury yields were underpinned by a better-than-expected Conference Board Consumer Confidence report. It came in at 118.9, beating the 116.1 forecast and 117.6 previous read.

ECB President Draghi got the ball rolling when he made optimistic remarks which may have opened the door to steps that might begin to reduce the central bank’s emergency stimulus to the economy.

“All signs now point to a strengthening and broadening recovery in the euro area,” Draghi said recognizing the improvements. However, he argued that the inflation dynamics aren’t solid enough to exit the stimulus program.

Philadelphia Fed President Patrick Harker helped provide support for the U.S. Dollar when he said he supports the decision to raise interest rates again this year, given recent inflation weakness, even though he predicts prices will take longer to rebound to the Fed’s goal.

“I’m sticking to my outlook that we’re on the right path,” Harker told the European Economics and Financial Center in London, according to his prepared remarks. “In the case of inflation, I’ve seen the factors exerting downward pressure as temporary.”

Fed Chair Janet Yellen spoke little about monetary policy, but reiterated her view that the Fed would raise interest rates slowly. She also said that she did not expect another financial crisis “in our lifetime”.

Early in the session, Treasury yields were underpinned by a better-than-expected Conference Board Consumer Confidence report. It came in at 118.9, beating the 116.1 forecast and 117.6 previous read.

Forecast

In order to continue the upside momentum, the USD/JPY is going to have to be fed a steady dose of rising U.S. Treasury yields. This could be difficult if the economy continues to deliver less-than-stellar results. Tuesday’s price action was a response to the movement in German Bunds and U.S. Treasury Bonds. Bullish Dollar/Yen traders would like to see both continue to weaken as yields rise.

What could derail the rally on Wednesday is a steep sell-off in U.S. equity markets. The NASDAQ Composite continues to look weak. And the inability to pass the health care reform bill in a timely manner may weaken the Dow and the S&P 500. This could send investors into the safe haven Japanese Yen.

In addition to Treasury yields and stock market weakness, investors will get the opportunity to react to the U.S. Goods Trade Balance, Preliminary Wholesale Inventories and Pending Home Sales.

At 1330 GMT, investors will get the chance to react to commentary from Bank of Japan Governor Kuroda. Early Thursday, Japan will release its latest data on retail sales.

We’re going to be watching the USD/JPY the next few days to see if the upside momentum continues. We want to make sure that Tuesday’s rally was real and not just a reaction to the hawkish commentary from Draghi and Harker.