Despite a small bounce on Wednesday, USD/JPY has been correcting lower in recent days, mirroring the drop in US Treasury rates.
Weakening US economic data and rising recession fears may undermine the US dollar against the Japanese yen in the coming days and weeks, according to the tight positive correlation between the USD/JPY and the US 10-year yield, and the US dollar may continue to weaken if Treasury rates continue to fall. Despite today’s modest gain, the pair has fallen from 128.20 to 127.15 in the last three days, a retreat that has coincided with the 10-year yield falling from 2.85 percent to 2.72 percent at the time of writing.
The Japanese yen appears to be in a better position to extend its recovery against the US dollar in the coming days and weeks, with the US recession narrative strengthening, Treasury rates pulling back from recent highs, Wall Street in free fall, and risk-off sentiment on the rise.
Although the divergence in monetary policy between the Federal Reserve and the Bank of Japan has been a major tailwind for the dollar in recent months, it is possible that we have reached peak US central bank hawkishness, at least for the time being and barring new inflation surprises. The Japanese yen may benefit from this.
The state of the US economy is another factor to consider when assessing the USD/JPY outlook.
In recent weeks, incoming economic data has disappointed expectations and revealed that activity is slowing much faster than expected, raising fears of a recession.
Concerns about a downturn have caused market participants to rethink the tightening cycle’s trajectory, and they no longer fully discount two half-point hikes by July. While expectations may shift again, current pricing indicates that traders believe the Fed will be unable to deliver on its promise to aggressively remove accommodation and front-load interest rate increases if the economy continues to contract at a rapid pace.
In terms of the economic calendar, the focus will be on the April U.S. PCE, which is scheduled for Friday.
Markets in the United States will be closed on Monday for the Memorial Day holiday, and traders are beginning to leave their desks for the long weekend, so liquidity conditions may worsen in the coming days. If key data surprises relative to expectations, thin liquidity could amplify price volatility. Look at the DailyFX calendar to see what traders are expecting.
In terms of technical analysis, the USD/JPY has bounced off support at 126.50 and appears to be heading towards trendline resistance at 127.40. If price overcomes this barrier, bulls may launch an assault on 128.40, the upper boundary of a short-term descending channel. The focus shifts higher to 129.75 as strength increases.
If sellers return and spark a bearish reversal, initial support ranges from 126.50/126.15. If this area is breached on the downside, the USD/JPY could be headed for the psychological 125.00 level.
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