USD/JPY OUTLOOK:
- Despite Wednesday’s small bounce, USD/JPY has been correcting lower in recent days, tracking the pull-back in U.S. Treasury rates
- Weakening U.S. economic data and rising recession fears may undermine the U.S. dollar against the Japanese yen in the coming days and weeks
- This article looks at the key technical levels in USD/JPY to watch in the short term and where there could be some kind of reaction
Most Read: EUR/USD Outlook – EURUSD Pullback Threatens Recent Gains
Last Friday, I discussed the tight positive correlation between the USD/JPY and the U.S. 10-year yield and argued that the U.S. dollar could continue to soften if Treasury rates extended their correction. This forecast has played out well so far, with the pair falling from 128.20 to 127.15 in the last three days, despite today’s modest advance, a retreat that has coincided with the 10-year yield falling from 2.85% to 2.72% at the time of writing.
The relevant question now, however, is whether the recent price dynamics will be sustained in the near term. Although the divergence in monetary policy between the Federal Reserve and the Bank of Japan has been a major tailwind for the greenback over the past few months, it is possible we have reached peak U.S. central bank hawkishness, at least for now and barring new surprises on the inflation front. This may benefit the Japanese yen.
Another variable to consider when assessing the USD/JPY outlook is the health of the US economy. In the last few weeks, incoming economic data has disappointed estimates and shown that activity is decelerating much faster than anticipated, raising fears that a recession may be just around the corner.
Concerns about a downturn have led market participants to reassess the trajectory of the tightening cycle and they now no longer fully discount two half-point hikes by July. While expectations could shift again, current pricing reveals that traders believe the Fed may not be able to deliver on its promise to aggressively remove accommodation and front-load interest rate increases should the economy continue to downshift at a precipitous pace.
With the U.S. recession narrative strengthening, Treasury rates pulling back from recent highs, Wall Street in free-fall, and risk-off sentiment on the rise, the Japanese yen appears to be in a better position to extend its recovery against the U.S. dollar over the coming days and weeks.
Turning to the economic calendar, the focus will be on April U.S. PCE scheduled for Friday. U.S. markets are closed next Monday for the Memorial Day holiday and traders starting to leave their desks for the long weekend, so liquidity conditions could deteriorate further in the coming days. Thin liquidity could amplify price volatility if key data surprises relative to expectations. Check out the DailyFX calendar to see what traders expect.
In terms of technical analysis, USD/JPY has bounced off support in the 126.50 zone and seems to be heading towards trendline resistance near 127.40. If price manages to clear this hurdle, bulls could launch an attack on 128.40, the upper boundary of a short-term descending channel. On further strength, the focus shifts higher to 129.75. On the flip side, if sellers return and spark a bearish reversal, initial support spans from 126.50/126.15. If this area is breached on the downside, USD/JPY could be on its way towards the psychological 125.00 level.
USD/JPY TECHNICAL CHART
USD/JPY chart prepared using TradingView
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—Written by Diego Colman, Market Strategist for DailyFX
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