USD/JPY Fundamental Daily Forecast – Weakens as Investors Pare View of Future Rate Hikes

The Dollar/Yen fell sharply on Friday and for the week after disappointing U.S. economic data supported the concerns expressed this week by several Fed policymakers, including Fed Chair Janet Yellen about the muted inflation since February.

The USD/JPY settled the session at 112.513, down 0.770 or -0.68%.

Sellers hit the U.S. Dollar hard on Friday, after weaker-than-forecast government data on consumer inflation and retail sales in June raised doubts about U.S. economic growth and whether the Federal Reserve would raise interest rates again in 2017.

U.S. consumer prices, as measured by the Consumer Price Index (CPI), were unchanged in June. Economists had forecast the CPI inching up 0.1 percent last month.

Retail sales fell 0.2% in June to mark the second straight drop and match the biggest decline of the year. Economists had forecast a 0.1% increase in June sales. May’s data was revised to 0.1%. The revision showed the previously reported decline was not as large.

Forecast

Both reports are likely to lead to a dampening of U.S. economic growth in the second quarter. Because of this, the Fed may not be able to raise interest rates the rest of the year. Going into the reports, traders had placed about a 55% to 60% chance of a rate hike in December. After the release of the reports, the chance of a third rate hike this year, dropped to 50%.

Investors also bought U.S. Treasury instruments on the news. This drove down U.S. Treasury yields, helping to tighten the spread between U.S. and Japanese government bonds. The direction of the interest rate differential will ultimately determine the direction of the USD/JPY.

Up until about mid-week, the interest rate differential had been widening in anticipation of tighter monetary policy by the Fed. Traders were also responding to the obvious divergence between the Bank of Japan, which favors a loose monetary policy, and the U.S. Federal Reserve, which favors a tight monetary policy.

Last week’s data is likely to mean more volatility for the Forex pair because investors will be more sensitive to U.S. economic data, especially data on inflation and growth. It also puts more importance on the next Federal Open Market Committee’s monetary policy decision on July 26. Up until Yellen made her remarks last Wednesday and the release of the government data, the central bank was widely expected to reiterate its comments about softening inflation being transitory. Now they may be forced to make a major statement about inflation and the direction of interest rates.