USD/JPY has been following a sad scenario. Yesterday, the currency pair neglected positive data from the US, which contributed to the growth of the greenback across the board, and followed a completely opposite trajectory. Why is the USD/JPY pair overwhelmed with pessimism and what could bring it back to life?
The US dollar is strengthening, but the yen is showing its teeth
In August, the dollar gained more than 2% against its Japanese counterpart. The main catalyst for the USD/JPY pair was the market's confidence that the significant divergence in monetary policy between the US and Japan would persist.
However, in the last days of August, traders revised their sentiments regarding the future monetary policies of both the Federal Reserve (FRS) and the Bank of Japan (BOJ). The market has been flooded by a wave of speculation that the US Fed is about to complete its tightening cycle and the Bank of Japan is sure to update its ongoing policy with hawkish rhetoric.
The sense that both regulators are on the brink of changes has provided substantial support for the yen last week. Currently, the USD/JPY pair is ready to halt its 5-week upward move. The instrument is on track to close the week with a 0.7% decline.
This week dealt a blow to the US dollar. A slew of weak economic data from the US hit the greenback, reinforcing investors' dovish sentiment toward further policy moves of the Federal Reserve and causing weakness in the greenback.
In contrast, yesterday dollar bulls found out a long-awaited sign of relief. The series of macroeconomic data turned out surprisingly robust, finally aiding the dollar in recovering from its slump.
The highly-anticipated report on Thursday was the core Personal Consumption Expenditures (PCE) price index, a key inflation barometer monitored by the Federal Reserve.
According to statistics, the core PCE deflator matched economists' expectations in July and logged a growth of 4.2% YoY and 0.2% MoM, compared to June's figures of 4.1% and 0.2% respectively.
The market fully understands that in conditions of sticky inflation, the scenario of the Fed's revision of monetary policy is unlikely, especially considering that yesterday, the head of Atlanta Federal Reserve Raphael Bostic spoke in favor of maintaining high rates.
The policymaker stated that the regulator should keep rates at a high level until it sees a clear course of inflation towards the central bank's target of 2%.
Besides, dollar buyers were encouraged by yesterday's weekly update from the US Department of Labor on initial jobless claims. For the week ending August 26, the indicator stood at 228,000, which is below the forecast of 235,000.
As we can see, the current employment situation contradicts the latest published data, such as the JOLTS report and the ADP release, which indicated that the American labor market is losing momentum which could have strengthened the market's dovish expectations for the Federal Reserve's policy.
This instilled hope in investors that the Nonfarm Payrolls on Friday could turn out stronger than economists predict. If so, the Fed's policymakers would express a more hawkish rhetoric.
Currently, traders assess the probability that the US central bank will leave rates unchanged at its September meeting at almost 90%, while the likelihood of another rate hike in November is only 45%.
Expectations of a stronger employment report allowed the US dollar index to rise by 0.51% against a basket of major currencies, reaching 103.71. Yesterday, the dollar showed excellent upward momentum against rival currencies, except for yen. USD/JPY closed yesterday at 145.42, down 0.5%.
Analysts explain this by the fact that the yen is currently strongly supported by the strengthening hawkish sentiment regarding the Bank of Japan's future monetary policy.
Last week, BOJ Governor Katsuo Ueda once again reaffirmed his dovish mantra about the need to maintain the current ultra-easy monetary policy, as the country still lacks stable underlying inflation.
Moreover, the Governor predicted further inflation deceleration in Japan. In his opinion, the core CPI could decline significantly by the year end.
However, this week traders heard a completely opposite opinion from Bank of Japan board member Naoki Tamura. The official stated that the regulator is gradually approaching its main goal of stable 2% inflation.
According to his forecasts, this task will be accomplished by early next year, allowing BOJ to proceed with the normalization of its monetary policy and move interest rates out of the negative zone.
The prospect of a monetary turnaround by the Bank of Japan is a powerful driver for the JPY. If more hawks emerge among Japanese officials ahead of the September BOJ meeting, this would further stimulate the yen's rise.
What awaits USD/JPY today?
As we mentioned earlier, on Friday, all traders' attention will be focused on the nonfarm payrolls for the US public and private sectors.
Currently, the consensus suggests that the US economy added 170,000 new jobs in August. If the forecast comes true or, even worse, it will arouse traders' concerns about soft hiring in the US labor market. In turn, such assumptions will trigger a new wave of speculation that the Federal Reserve has already completed its current tightening cycle.
Analyst Stephen Innes warns that a significant drop in August employment data or a notable increase in the unemployment rate will cast doubt on the prevailing belief that the Federal Reserve is ready to maintain its hawkish stance for an extended period.
This will deal a serious blow to the US dollar and send it into free fall across the board. The yen will gain the most from the weakness of the greenback, especially given the hawkish sentiments towards the Bank of Japan.
The USD/JPY pair can gain upward momentum only if the Nonfarm Payrolls shock investors in a pleasant way by showing strong job growth in the US labor market. Is such a scenario possible?
Most experts consider it unlikely, given the negative trend of the past three months. Starting from May, the average NFP figure has decreased by half compared to the previous year, reaching 218,000. This indicates that the US labor market is steadily cooling down.
Thus, the outlook for USD/JPY is currently tilted downwards. Analysts reckon that the instrument may test 144.54, the low of August 23.
