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Dovish FOMC Rate Hike to Rattle USD/JPY Rate Recovery

Dovish FOMC Rate Hike to Rattle USD/JPY Rate Recovery

David Song,

Fundamental Forecast for Japanese Yen: Neutral

USD/JPY appears to be on its way to test the November-high (114.74) as the Federal Reserve is widely expected to deliver a 25bp rate-hike on December 13, but the fresh updates from Chair Janet Yellen and Co. may rattle the near-term recovery in the exchange rate should the central bank highlight a more shallow path for the benchmark interest rate.

The 228K expansion in U.S. Non-Farm Payrolls (NFP) may encourage the FOMC to raise the fed funds rate to a fresh threshold of 1.25% to 1.50% as the economy appears to be approaching full-employment. However, the below-forecast reading for Average Hourly Earnings may force the committee to adopt a more cautious tone as many officials note ‘that continued low readings on inflation, which had occurred even as the labor market tightened, might reflect not only transitory factors, but also the influence of developments that could prove more persistent.’

With that said, market participants pay increased attention to the U.S. Consumer Price Index (CPI) as the headline reading is anticipated to pick up to an annualized 2.2% from 2.0% in October, but another 1.8% print for the core rate of inflation may ultimately dampen the appeal of the greenback as ‘a decline in longer-term inflation expectations would make it more challenging for the Committee to promote a return of inflation to 2 percent over the medium term.’

As a result, the FOMC may largely endorse a wait-and-see approach going into 2018, and a growing number of Fed officials may trim the longer-run forecast for the benchmark interest rate as ‘many participants observed that there was some likelihood that inflation might remain below 2 percent for longer than they currently expected.’ Forecasts pointing to a more shallow path for the benchmark interest rate is likely to rattle the near-term rebound in USD/JPY, with the pair at risk of exhibiting a more bearish behavior over the remainder of the year as the Fed runs the risk of concluding its hiking-cycle ahead of schedule.

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USD/JPY Daily Chart

Near-term outlook for USD/JPY remains constructive as the pair snaps the monthly opening range and starts to carve a series of higher highs & lows, with the November-high (114.74) on the radar as Relative Strength Index (RSI) breaks out of the bearish formation carried over from November. Keep in mind, USD/JPY has marked a string of failed attempts to close above the Fibonacci overlap around 113.80 (23.6% expansion) to 114.30 (23.6% retracement), with the pair at risk of largely repeating the price action from the summer months should the FOMC tame expectations for higher interest rates.

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.