USD/JPY Rate Outlook Mired by Inverting Yield Curve, Wait-and-See Fed

Japanese Yen Rate Talking Points

USD/JPY struggles to retain the rebound from earlier this week, with the exchange rate trading in a narrow range going into the end of the month, but recent developments raises the risk for a further decline as both price and the Relative Strength Index (RSI) snap the bullish trends from earlier this year.

USD/JPY remains under pressure even as U.S. Treasury Secretary Steven Mnuchin and Trade Representative Robert Lighthizer land in China to nail out a trade deal, and the Japanese Yen may continue to benefit from the current environment as the weakening outlook for global growth drags on risk-taking behavior.

Carry trade interest appears to be dwindling as the inversion in the U.S. Treasury yield curve warns of a looming recession, and developments coming out of the worlds largest economy may continue to impact risk sentiment as fresh updates to the Gross Domestic Product (GDP) dampens the outlook for growth.

The final revision to the GDP report showed the growth rate narrowing to 2.2% from an initial forecast of 2.6%, with the gauge for private-sector spending highlighting a similar dynamic as Personal Consumption slipped to 2.5% from a preliminary reading of 2.8%. However, a deeper look at the report showed the core Personal Consumption Expenditure, the Federal Reserve‘s preferred gauge for inflation, unexpectedly climbing to 1.8% from 1.7%, and signs of sticky price growth may deter Chairman Jerome Powell and Co. from switching gears as the central bank pledges to be ’data dependent.

Fresh remarks from Fed officials suggest the central bank will retain the wait-and-see approach at the next interest rate decision on May 1 as Kansas City Fed President Esther George, a 2019-voting member on the FOMC, wants to see how the four rate-hikes from 2018 ‘moves through the economy.’ However, the Federal Reserve may have a difficult time in defending the shift in forward-guidance as inflation holds near the 2% target, and the committee may look to tame expectations for lower interest rates as Fed Fund Futures still reflect a greater than 70% probability for a rate-cut in December.

With that said, the U.S. dollar stands at risk of facing headwinds over the coming months amid growing bets for a Fed rate-cut, but the recent pickup in USD/JPY volatility continues to shake up market participation as retail interest recovers from an extreme reading.

The IG Client Sentiment Report shows 52.6%of traders are now net-long USD/JPY compared to 56.1% earlier this week, with the ratio of traders long to short at 1.11 to 1.The number of traders net-long is 5.2% lower than yesterday and 3.1% lower from last week, while the number of traders net-short is 4.1% lower than yesterday and 3.0% higher from last week.

Keep in mind, traders were net-short since February 27, with the ratio slipping to an extreme reading earlier this month, but the IG Client Sentiment index has recovered since then amid the recent pickup in net-long interest. Moreover, the last time the sentiment index showed a similar dynamic was back in December, with the retail crowd turning heavily net-long ahead of the currency market flash-crash in January.

The flip in retail interest warns of a broader shift in USD/JPY behavior, with recent developments raising the risk for a further decline in the exchange rate as both price and the Relative Strength Index (RSI) snap the bullish trends from earlier this year. Sign up and join DailyFX Currency Analyst David Song LIVE for an opportunity to discuss potential trade setups.

USD/JPY Rate Daily Chart

• The USD/JPY correction following the currency market flash-crash may continue to unravel as price and the RSI snap the bullish trends from earlier this year.

• Still waiting for a break/close below the Fibonacci overlap around 109.40 (50% retracement) to 110.00 (78.6% expansion) to open up the February-low (108.72), which sits just above the next downside hurdle around 108.30 (61.8% retracement) to 108.40 (100% expansion).

• Next area of interest comes in around 106.70 (38.2% retracement) to 107.20 (61.8% retracement) followed by the 105.40 (50% retracement) region.

For more in-depth analysis, check out the Q1 2019 Forecast for the Japanese Yen

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--- Written by David Song, Currency Analyst

Follow me on Twitter at @DavidJSong.