USD/JPY Weekly Forecast: Before the Fed and after

USD/JPY and the dollar revive after Fed meeting.
FOMC and Chair Powell signal March fed funds increase.
Treasury yields rise as Fed inflation fight comes into focus.
Japanese inflation weakens, pinning BOJ policy to accomodation.
The Federal Reserve meeting on Wednesday not only came at mid-week but it split trading into two distinct halves. Before the Fed and Chair Jerome Powell’s press conference Dollar yen had dropped below 114.00 on Friday for the first time since December 21, and closed there for three days running.

After the Federal Open Market Committee (FOMC), 114.00 and 114.50 disappeared and 115.00 vanished on Thursday. The formerly defunct trend line from late September that had been broken conclusively on January 12 and 13, was recrossed at 115.20 on the way to Thursday’s close at 115.36.
Tokyo took the pair to 115.69 on Friday but US PCE inflation deflated the brief surge back to the day’s start line at 115.40.
“With inflation well above 2 percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate,” said the FOMC statement accompanying the decision to to leave the fed funds rate unchanged at 0.25% and to end the bond purchase program in March, as ordered at the December meeting. The Fed also issued guidelines for reducing its $9 trillion balance sheet.

Fed Chair Jerome Powell’s question and answer commentary beginning 30 minutes later, reinforced and extended the clear intent to begin a rate cycle at the March 16 meeting.

“I think there’s quite a bit of room to raise interest rates without threatening the labor market,” was one of a slew of responses that prompted immediate reactions from traders in the equity, credit and currency markets.

(See our coverage of the Fed meeting: Federal Reserve rate cycle to begin in March, markets reverse on warning)

Equities reversed sharply on Wednesday as the Fed’s plans became ever more transparent with Mr.Powell’s remarks.

The S&P 500 and the Dow shed large prior gains, 2.2% and 1.5% respectively to end in negative. The NASDAQ lost its 3.4% improvement finishing up just 2.82 points. Thursday’s trading was volatile, swaying between gains and losses but at the close the Dow was off 0.02%, the S&P 0.54% and the NASDAQ 1.4%.

Treasury returns rose after the Fed meeting, particularly at the short end of the yield curve in the 2-year and 5-year securities. From Monday’s open at 1.016%, the 2-year yield had added 17 basis points to 1.18% just before Friday’s open. The 5-year return had climbed 8 points from 1.576% at the start of the week to 1.66%. The 10-year added 6 basis points to 1.83% and the 30-year was just 4 points higher on Thursday at 2.125%..

The dollar was higher in all pairs on Wednesday and the gains continued on Thursday with the euro closing at a 20 month low at 1.1143. The US currency set new 2022 highs against every major competitor on Thursday.

Third quarter Gross Domestic Product for the US, issued on Thursday was much stronger at 6.9% than the 5.4% forecast.This gave the dollar an additional boost as it suggested the performance of the economy had a better base to start the New Year. Durable Goods were weaker than predicted in December though November’s results were revised markedly higher. Jobless claims fell back from their 13 week peak on January 14, but the four-week average remained at a two-month high. Rising unemployment claims have been carefully watched for signs that the US economy is slowing. Inflation scored another record for the Personal Consumption Expenditure Price Index (PCE) in December with 4.9% for core and 5.8% for the overall. Personal Income fell 0.2% in December and Personal Spending dropped 0.6% as expected.

Japanese data was limited. Annual Tokyo CPI was slightly less than expected at 0.5% in January, and down from 0.8% in December which had been the highest in 24 months. Core inflation fell to -0.7%, more than twice the -0.3% pace in December.

USD/JPY outlook
The diverging rate policy of the US Federal Reserve and the Bank of Japan (BOJ) remains the fundamental fact motivating traders. The Fed’s aggressive approach to inflation at Wednesday’s meeting, especially the extended discussion of the balance sheet reduction, seems to have convinced the credit and currency markets that the governors’ recent conversion to a tighter monetary policy is genuine. By historical levels, there is considerable room for US Treasury rates to rise.

US 2-year Treasury yield

The fourth quarter GDP figures provided some assurance that the US economy will continue to grow fast enough to withstand the steady application of higher interest rates.

Mr. Powell’s comment that , “I think there’s quite a bit of room to raise interest rates without threatening the labor market,” brought the point home given the Fed’s protracted attention to the job market over the past two years.

The BOJ will not tighten policy in the near future. If anything, another spending package can be expected from Prime Minister Fumio Kishida government, a pointless but by now, traditional endeavor for a new leader.

Japanese industrial production for December is expected to decline as is Retail Trade (sales). Consumer Confidence has been down for so long that any positive movement would be notable, none is forecast for January. Recently imposed Omicron restrictions may dampen economic activity in the first quarter.

In the US Nonfarm Payrolls for January and Purchasing Managers Indexes are the main events. Job creation is expected to be modest at 200,000, in line with the two previous months. Any improvement would support Treasury rates and the dollar.

Federal Reserve policy is enabled by the growth of the US economy. As long as the major economic indicators, GDP, payrolls, jobless claims and consumption remain stable or improve, the FOMC will follow the inflation deterrence it has publicly charted.

The USD/JPY bias is higher with a return to 115.60 the initial target followed by the four-year high of 116.35 from January 4.

The fourth quarter GDP figures provided some assurance that the US economy will continue to grow fast enough to withstand the steady application of higher interest rates.

Mr. Powell’s comment that , “I think there’s quite a bit of room to raise interest rates without threatening the labor market,” brought the point home given the Fed’s protracted attention to the job market over the past two years.

The BOJ will not tighten policy in the near future. If anything, another spending package can be expected from Prime Minister Fumio Kishida government, a pointless but by now, traditional endeavor for a new leader.

Japanese industrial production for December is expected to decline as is Retail Trade (sales). Consumer Confidence has been down for so long that any positive movement would be notable, none is forecast for January. Recently imposed Omicron restrictions may dampen economic activity in the first quarter.

In the US Nonfarm Payrolls for January and Purchasing Managers Indexes are the main events. Job creation is expected to be modest at 200,000, in line with the two previous months. Any improvement would support Treasury rates and the dollar.

Federal Reserve policy is enabled by the growth of the US economy. As long as the major economic indicators, GDP, payrolls, jobless claims and consumption remain stable or improve, the FOMC will follow the inflation deterrence it has publicly charted.

The USD/JPY bias is higher with a return to 115.60 the initial target followed by the four-year high of 116.35 from January 4.