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USD/JPY Outlook Hinges on Fed’s Forward Guidance for US Rates

USD/JPY Outlook Hinges on Fed’s Forward Guidance for US Rates

David Song, Strategist

Japanese Yen Talking Points

USD/JPY struggles to push back above the 50-Day SMA (113.65) as longer-dated US Treasury yields fall for the third consecutive day, but the Federal Reserve interest rate decision on December 15 may spark a near-term rally in the exchange rate if the central bank shows a greater willingness to implement a rate hike sooner rather than later.

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USD/JPY Outlook Hinges on Fed’s Forward Guidance for US Rates

Recent price action in USD/JPY instills a constructive outlook as it clears the opening range for December after defending the November low (112.53), and the exchange rate may continue to exhibit a bullish trend following the Fed’s last meeting for 2021 as the central bank carries out its exit strategy.

Image of DailyFX Economic Calendar for US

It remains to be seen if the update to the US Consumer Price Index (CPI) will influence the Federal Open Market Committee (FOMC) as the headline reading hits a 40 year high, but market participants appear to be bracing for an adjustment in the forward guidance for monetary policy as the central bank is slated to update the Summary of Economic Projections (SEP).

Image of Federal Reserve interest rate dot plot

Source: FOMC

As a result, the interest rate dot-plot may sway the near-term outlook for the US Dollar as St. Louis Fed President James Bullard, who votes on the FOMC in 2022, argues that the central bank “may want to consider removing accommodation at a faster pace,” and USD/JPY may continue to appreciate over the coming months if Chairman Jerome Powell and Co. project a steeper path for the Fed funds rate.

At the same time, more of the same from the Fed may drag on the Greenback as market participants push out bets for higher US interest rates, but the tilt in retail sentiment looks poised to persist as long as USD/JPY exhibits a bullish trend.

Image of IG Client Sentiment for USD/JPY rate

The IG Client Sentiment report shows only 37.46% of traders are currently net-long USD/JPY, with the ratio of traders short to long standing at 1.67 to 1.

The number of traders net-long is 10.40% higher than yesterday and 6.33% higher from last week, while the number of traders net-short is 8.25% higher than yesterday and 13.74% higher from last week. The rise in net-long interest has done little to alleviate the crowding behavior as 39.37% of traders were net-long USD/JPY last week, while the rise in net-short position comes as the exchange rate struggles to trade back above the 50-Day SMA (113.65).

With that said, USD/JPY may face a large pullback ahead of the Fed rate decision as longer-dated US yields remain under pressure, but the diverging paths between the FOMC and Bank of Japan (BoJ) may continue to foster a bullish trend in the exchange rate as Chairman Powell and Co. appear to be on track to implement higher interest rates in 2022.

USD/JPY Rate Daily Chart

Image of USD/JPY rate daily chart

Source: Trading View

  • The broader outlook for USD/JPY remains constructive as it trades to fresh yearly highs throughout the second half of 2021, with the 200-Day SMA (110.68) indicating a similar dynamic as it retains the positive slope from earlier this year.
  • The Relative Strength Index (RSI) showed a similar dynamic as it pushed into overbought territory for the first time since the first quarter of 2021, but a textbook sell signal materialized in October as the oscillator fell back from overbought territory to slip below 70.
  • Nevertheless, USD/JPY cleared the November 2017 high (114.74) as it broke out of a bull flag formation, with the exchange rate taking out the March 2017 high (115.50) in November even as the RSI failed to push into overbought territory.
  • In turn, the decline from the yearly high (115.52) may turn out to be a correction in the broader trend as USD/JPY defends the November low (112.53), but lack of momentum to push back above the 50-Day SMA (113.65) may push the exchange rate back towards the 112.40 (61.8% retracement) to 112.40 (38.2% expansion) region.
  • Need a break/close above the Fibonacci overlap around 113.80 (23.6% expansion) to 114.30 (23.6% retracement) to bring the November high (115.52) on the radar, with the next area of interest coming in around 115.90 (100% expansion) to 116.10 (78.6% expansion).

--- Written by David Song, Currency Strategist

Follow me on Twitter at @DavidJSong

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

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