USD/JPY: Back to Square One for Dollar Bulls
April 28, 2016 @ 11:46 GMT
USD/JPY has taken heavy punishment following Bank of Japan inaction Wednesday and very sharp yen gains will encourage further short-term speculative buying. The central bank will maintain an expansionary monetary policy and is still likely to ease policy further in June with the Fed likely to move rates higher. Overall monetary and capital-account trends are likely to weaken the yen over the medium term, but dollar bulls will need to successfully defend support levels above 107.50 to avoid having to start the bull run from lower levels.
The dollar was resilient following a generally tepid Federal Reserve policy statement on Wednesday with just enough confidence in the outlook to prevent dollar losses as underlying Fed inflation doubts continued. There was, however, heavy selling pressure on the US currency following the Bank of Japan policy decision.
The latest economic data supported the case for further monetary action with a weaker than expected reading for consumer inflation and weak data on household spending. In the latest outlook report, the central bank also downgraded GDP estimates and again pushed back the expected time frame for reaching the 2% inflation target to 2018 at the latest.
Crucially, however, there was no move to ease monetary policy further following the meeting. Analysts were divided over the potential for further action at this meeting, but market confidence in a move had been building ahead of the decision, which led to heavy dollar selling as expectations were disappointed. USD/JPY plunged lower with a trough just below 108.00 before some respite.
The immediate focus will be on support levels below 108.00 with lows of 107.63 on April 11th and 107.84 on April 18th. Another successful test of these support area would boost confidence in a triple bottom, while a break below invites talk of a slide to 105.00.
There are still record high long speculative positions in the yen and the dollar’s sharp reversal has lessened the risk of any sustained position squeeze in the short term. Over the medium term, such aggressive positioning still suggests big dangers in chasing the yen stronger.
The Bank of Japan will maintain its policy of expanding the monetary base and is maintaining an aggressive monetary policy. There is also a strong probability that policy will be loosened again at June’s meeting unless there has been a big improvement in the inflation profile.
As far as the Federal Reserve is concerned, it is edging slightly closer to a policy tightening and stronger inflation data over the next few weeks would put a June rate move firmly on the agenda. In nominal term, the US yield gap will remain attractive and is likely to widen over the second half of 2016, as Japanese yields stay negative. US yields have, however, moved sharply lower over the past 24 hours and they are not attractive in real terms.
Capital-account data has continued to show heavy Japanese flows into overseas bond markets. These flows will be important in curbing the potential for any yen appreciation over the medium term as they offset the current account surplus.