USD/JPY forecast: Attention turns to US CPI as yen drops across the board

The USD/JPY extended its gains for the third day, even if the US Dollar Index was little changed on the week ahead of key US data. The yen has therefore fallen across the board. This is in part because of improved risk appetite hurting the appeal of the perceived haven currency, while rising US bond yields are also a major factor. The focus for is now turning to data with the release of US CPI today, PPI tomorrow and retail sales on Friday. The USD/JPY will get a boost should inflation data surprise to the upside.

Trade war concerns shrugged off

Investors have been keeping an eye on Trump’s trade war. The latest tariff news on steel and aluminium from Trump have been largely ignored by traders who feel that the US President is using it as a negotiation tactic. Hence, we have seen stock markets in Germany for example hit repeated all-time highs. Given that the tariffs are set to take effect on March 4 unless a deal is agreed upon before then, the stock markets are not very concerned about this for now. But let’s see if Trump announces any further measures and how that might impact the markets.

Rising bond yields underpin USD/JPY forecast

One thing that is becoming clear is the rising bond yields, which have bounced back after Friday’s strong jobs report. Among other things, the report showed that wage growth increased by 0.5%. Additionally, the University of Michigan’s inflation expectation survey surged more than expected, reigniting inflation uncertainty. As a result, bond yields have risen as investors push out expectations that the Fed will cut interest rates soon. This has also caused the US dollar to stage a bit of a comeback, especially against low-yielding currencies such as the Japanese yen.

Yesterday, the focus was also on the Fed Chair Jay Powell’s testimony. He was always unlikely to say anything dovish, especially with key US inflation data coming up. Lo and behold, Powell said that they do not need to be in a hurry to adjust policy. As a result, traders have upped their USD/JPY forecast on the view that the yield differential between the US and Japan will not narrow as much as it had appeared to be the case just last week.

CPI among this week’s key data highlights

US CPI is out later today, which comes hot on the heels of data on Friday showing a sharp rise in inflation expectations and a bigger-than-expected increase in average hourly earnings. Both of these measures suggest inflationary pressures might be on the rise again and for that reason the Fed will not be in a hurry to cut rates further. Headline CPI is expected to come in at 2.9%, unchanged from the previous reading. We will also see PPI data on Thursday and retail sales figures on Friday, making for an eventful week in terms of economic releases.

If inflation data comes in hotter than expected, we could see the USD/JPY climb to 155.00, while a rather weak print should cause yields to decline again and take the pair lower with it.

Technical USD/JPY forecast: Key levels to watch

Source: TradingView.com

From a technical point of view, the USD/JPY is in a range bound environment despite its 3-day rally. It has bounced back from around the 151.00 area, where prior resistance-turned-support held and drop the exchange rate back above the 200-day average of around 152.50/60 area. The key question now is whether it can hold its ground above the 200-day moving average. If it does, this could pave the way for a recovery towards the 155.00 handle, now that it has already touched the base of the previous week's breakdown at around 153.70 zone. This level is now the most important short-term resistance to watch. On the downside, if support around the 152.50/60 area breaks, the next downside target is 151.00, followed by the psychologically significant 150 handle.

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R

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