USD/JPY Volatility Dictated By U.S. Interest Rate Expectations, But For How Long?

USD/JPY

The USD/JPY has been under pressure ever since Fed Chairman Ben Bernanke threw cold water on the prospect that the central bank would start tightening in the near-term. U.S. interest rate expectations and the dollar soared following a better than expected Non-farm payroll report sending the pair higher before the top policy maker recommitted to leaving rates low for the foreseeable future. The correlation between the pair and U.S. yield expectations also jumped to 0.33 from -0.4 a week ago as they have been in lock step. However, with the outlook for future tightening firmly anchored again, we expect to see its influence over price direction weaken. If yields start to take a back seat again the risk trends may grow in importance as they saw their influence fall to 11% from 20% a month ago.

BoJ Interest Rate Expectations

The Japanese government approved a 10 trillion yen stimulus package yesterday and today the second reading of Japanese GDP was revised lower to 1.3% from 4.8% which reinforced expectations that the BoJ will leave rates on hold for an extended period. Overnight index swaps are now pricing in a reduction in the benchmark rate of 1 bps which is a sharp reversal from the 15 bps of rate hikes that markets were pricing in following the announcement of the central bank’s emergency meeting as speculation increased that intervention measures would be initiated.  To discuss this and trading ideas join the USD/JPY forum.

FOMC Interest Rate Expectations

U.S. interest expectations have resumed their downward trend as the impact from the labor report is starting to dissipate with markets now pricing in a 12.4% chance of a rate hike by March. The dovish comments from Chairman Ben Bernanke have lowered yield expectations. The central bank leader warned that household spending is “unlikely to grow rapidly” as credit remains tight and the job market weak. Despite November’s improvement, unemployment remains at a debilitating 10.0% which the Fed chairman says will lead to a moderate recovery pace. Bernanke would go onto say that the Fed is still looking at an extended period before beginning tightening as long-run inflation expectations are stable.

Risk

Equity markets have started to consolidate as they weigh improving fundamentals against dovish rhetoric from policy makers. Despite, improvements in employment and the service sector the outlook for consumer consumption remains bleak with tight credit markets and an increasing savings rate. Meanwhile, the prospect of a low interest rate environment is providing support as cheap money will offset some of the impact from lower sales and help bottom lines continue to remain positive. The concentrated price action could transfer to the USD/JPY if risk trends grow in influence. To discuss this and other fundamental data join the Economics Forum.

To discuss this report or be added to the email list contact John Rivera, Currency Analyst: jrivera@fxcm.com