The USD/JPY exchange rate remained above 144 on Wednesday as investors watched the ongoing performance of the bond market. It was trading at 144.2, down from this month’s high of 148.67. This article explores the outlook of the Japanese yen as bond fears remain.
Japanese yen rises as bond yields rise
One of the top macro stories this week is the performance of the Japanese bond market.
This performance is mostly because of the structure of Japan’s bond market, an area where the Bank of Japan dominates. In the past decade, the bank has been buying bonds worth billions of dollars a month through its quantitative easing program.
The bank has now changed tune and is rising interest rates, trimming its balance sheet, and scaling back its purchases. The question among investors is on who is interested in these Japanese bonds.
Recent data shows that demand from investors remained tepid. On May 20th, a 40-year auction met the lowest demand in over a decade, while another one had the lowest demand in ten months.
A likely solution for Japan will be to unwind the carry trade that has existed in over a decade. Japan may start selling its US bonds as the Federal Reserve considers cutting interest rates. It will then shift some of these funds to the domestic market.
Japan bond yields have jumped because of the rising concerns about the economy and the rising default risks. Just recently, Prime Minister Shigeru Ishiba warned that the economy was facing a situation worse than the Greece crisis a few years ago.
All these issues have put the Bank of Japan (BoJ) in a difficult position as it battles a high inflation rate. Recent data showed that the headline Consumer Price Index (CPI) stood at 3.6%, much higher than its target rate of 2.0%. Increasing interest rates will make the cost of borrowing in Japan much higher.
FOMC minutes and key data ahead
The USD/JPY exchange rate rose after the US published strong consumer confidence data on Monday. According to the Conference Board, consumer confidence rose to 97 in May as Donald Trump showed openness to reach a deal with other countries.
The next key catalyst for the USD/JPY pair will be the FOMC minutes, which will come out on Wednesday. These minutes will provide more information about the deliberations in the last monetary policy meeting.
However, their impact on the US dollar index will be limited because most investors have ruled out any rate cut in the upcoming meeting.
The USD/JPY pair will also react to the upcoming US GDP and personal consumption expenditure (PCE) data on Thursday and Friday, respectively.
Like the Fed minutes, their impact on the US dollar will be limited as the Fed has already said that it will embrace a wait-and-see approach.
USD/JPY technical analysis
The daily chart shows that the USD/JPY exchange rate remains under pressure this year. It has moved below the 50-day and 100-day Exponential Moving Averages (EMA), a sign that bears remain under control.
Th pair has also formed an inverse head and shoulders pattern. This pattern comprises a rounded top and a handle. It is now forming the handle section.
Therefore, the mostv likely scenario is where the USD/JPY pair continues its downward trend, with the initial target being the support at 139.85. A move below that level will see the pair continue falling in the next few days.
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