USD/JPY has been in a strong downtrend since the end of 2017 and analysts expect this trend to end soon but there is a real possibility of this pair continuing downwards in the short term before finding support.
The dollar index saw around a quarter percent gain last week after some choppy trading following the release of employment data on Friday. The non-farm payrolls for February came in much higher than expected, with the figure being the highest seen in 18 months at 313,000. However, both the monthly and yearly wage increases were lower than expected, easing fears that the Fed’s inflation target would be met sooner than predicted. The unemployment rate also missed forecasts and remained the same as January after a large increase in the labor force. In terms of monetary policy, this data does very little to change that and the Fed remain firmly on course for three rate hikes this year. The potential of a fourth hike remains but we would need to see stronger wage growth in the coming months for traders to really start pricing this in.
As pointed out by the Fed’s Kashkari, this NFP report suggests that we are not at full employment in the United States as other Fed members and analysts have been suggesting. When we do close in on a full employment level, we would expect NFP figures to get lower along with an increase in wages which would show that employers are competing for a scarce workforce.
Fed’s Brainard, generally considered a dove, also spoke during the week and she was optimistic about the economy. She also mentioned that gradual rate hikes would be appropriate. This follows on from the testimony given by Fed Chair Powell a couple of weeks ago in which analysts interpreted the hawkish tone and the term “gradual” to mean that four hikes was certainly possible for the year. Fed’s Evans also spoke to Bloomberg TV during the week and pointed out that usually during a recession, the Fed lowers rates by around 500 basis points. When the Fed began hiking rates, it was expected that the aim would be to get rates to around 3-4%. However, Evans’s statement suggests that the Fed may be looking for an additional 50-100 basis points to give them more room. Although we are quite a distance away from these levels, this will be worth keeping in mind in about a year from now.
In addition, reports during the week showed that Japanese investors have recently been investing more heavily into the European bond market whilst withdrawing investments from the US bond market. There are also fears of China selling their US bonds or halting purchases. US debt is expected to significantly increase over the coming months and years and with the Fed also unwinding, a lack of buyers in the US treasury market could force an increase in rates.
Meanwhile, in Asia, the Bank of Japan are sticking with their dovish policy stance and there is little sign of this changing anytime soon. One central bank member was against this policy stance and actually suggested that the markets should be warned of potential further monetary policy easing if required. Overall, the statement and GDP figures from earlier in the week suggested that the central bank are satisfied and optimistic on growth but they also have no intentions to make changes to the policy until their inflation target of 2% is hit. The Bank of Japan expects to hit this target by mid-2019 but the majority of analysts think it could take much longer.
From this, we can see that the policy divergence between the US and Japan is likely to remain for quite some time, yet this pair has been moving downwards since the start of 2017. The general sentiment amongst market participants and analysts is that this is a correction for the pair and an upwards move should begin in the coming months. However, it should also be noted that US dollar weakness is expected to continue against other major currencies.
Our opinion on this pair is that it will move upwards but a further pullback towards the 100.00 handle is possible. The key levels for this pair over the next few weeks will be 108.00 and 105.00. If price was able to break the 108.00 level, we could see the start of a long term move upwards. If 105.00 was broken, we would then expect the price to move towards 100.00 before making a long term reversal.
