USD/JPY Fundamental Daily Forecast – Size of Dollar’s Rally Will Be Determined by Yellen’s Tone

The USD/JPY is surging to the upside on Tuesday in the wake of a hawkish speech by European Central Bank President Mario Draghi and hawkish commentary from Federal Market Open Committee Member Patrick Harker.

Traders are now awaiting a speech by U.S. Federal Reserve Chair Janet Yellen and a subsequent question and answer session. The price action suggests that traders expect her to reiterate her hawkish stance that the Fed is likely to raise interest rates at least one more time in 2017 and that the current weakness in inflation is only temporary.

We could see tremendous downside volatility if Yellen comes out even a little less-hawkish, but definitely if she comes across as dovish.

Earlier in the session, the call for higher interest rates in the Euro Zone received a boost after ECB President Mario Draghi seemed to indicate that the central bank may be taking steps towards reducing its emergency stimulus to the economy.

At a conference in Portugal, Draghi said the ECB could adjust its policy tools of sub-zero interest rates and massive bond purchases as economic prospects improve in Europe.

Although Draghi didn’t say anything specific or set any timetables, just the fact that he is even talking about the central bank’s options is being seen as a hawkish sign by speculators at this time.

The Dollar/Yen strengthened further at the mid-session after hawkish remarks from Philadelphia Fed President Patrick Harker. He said he remains confident about the direction of U.S. interest rates in 2017.

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

“I still support the continued gradual removal of accommodation,” Harker said. “I still see another rate hike as appropriate for 2017.”

We could see further upside action as Yellen delivers her speech at 1700 GMT. She is taking part in discussion on global economic issues in London.

Investors expect Yellen to reiterate her positive outlook for the U.S. economy despite the recent weak data that she sees as temporary. She is also expected to reinforce the central bank’s plan to raise rates once more this year and three times next year.

The dollar is likely to rally against the Yen if she only reiterates her stance. It will move sharply higher if she reinforces the need for one more rate hike this year. I think the strongest upside reaction by the dollar will take place if she says the Fed is on track for three more rate hikes in 2018.