Bullish USD/JPY Outlook Mired by Dovish Fed, Wait-and-See BoJ

See how retail traders are positioning in the majors using the FXCM SSI readings on DailyFX's sentiment page.

The diverging paths for monetary policy fosters a long-term bullish outlook for USD/JPY, but the Federal Reserve’s and the Bank of Japan’s (BoJ) wait-and-see approach may continue to drag on the exchange rate especially as Janet Yellen and Co. look to further delay their normalization cycle.

With Fed officials now projecting two rate-hikes for 2016, the less-hawkish stance accompanied by the downward revision in the growth rate may keep the dollar under pressure even as the U.S. economy approaches ‘full-employment.’ The external risks surrounding the region may encourage the Federal Open Market Committee (FOMC) to stay on hold throughout the first-half of this year, and Chair Janet Yellen may make further attempts to buy more time amid the slowdown in the global growth. With that said, the cautious outlook laid out by the FOMC may continue to drag on interest-rate expectations and spur further losses for the greenback as the Fed forecasts remain susceptible to a further downward revision at the next quarterly meeting in June.

At the same time, the BoJ may stick to the sidelines for the foreseeable future and may even scale back its willingness to implement more conventional/non-conventional tools as the central bank continues to gauge the impact of negative interest rates. In turn, Governor Haruhiko Kuroda may strive to jawbone the local currency especially as the central bank struggles to achieve the 2% target for inflation, but the slowdown in the global economy accompanied by the decline in risk-appetite may continue to boost the appeal of the Japanese Yen as it largely preserves its role as a funding/safe-haven currency. With Japan moving back to its historic current-account surplus, the improvement in the Balance of Payments (BoP) may spur greater demand for the Yen as the world economic outlook remains clouded with high uncertainty.

As a result, the dollar-yen may depreciate further over the coming months as U.S. interest-rate expectations come under pressure, while efforts by the BoJ to weaken the local currency may ultimately fail to bear fruit especially as global investors scale back their appetite for risk.

Japanese Yen’s ‘Funding-Currency’ Status Raises Risk for Larger USD/JPY Correction

The Japanese Yen’s ‘funding-currency’ status may continue to play a key role in dictating price ahead of the key interest rate decisions as USD/JPY broadly moves in tandem with the global benchmark equity indices.

USD/JPY & S&P 500

Data source: Bloomberg. Chart Prepared by David Song

Indeed, efforts by the community of global central bankers to avert a further slowdown in the world economy may prop up market sentiment, but fear of a ‘hard-landing’ in China paired with the weakened outlook for Emerging Markets may continue to sap investor confidence and spark a further unwinding of the ‘carry trade.’ In turn, shifts in risk trends may largely accompany turns in USD/JPY as market participants weigh the outlook for monetary policy.

Technical Analysis: USD/JPY Forecast to Hit Lows

Chart source: TradingView. Prepared by David Rodriguez

Our technical forecast for the USD/JPY has turned firmly bearish as the pair breaks sharply below its 52-week Simple Moving Average and trendline support (not shown). Past performance is not indicative of future results, but the 52-week SMA has for the past several decades marked the major USD/JPY trend. Or in other words, trading below the key moving average has marked downtrends and trading above has marked uptrends. We feel that this instance could be similar, and notable trader positioning acts as further confirmation.

CFTC COT Data Shows Net Non-Commercial Positions now Sharply Net-Short

Data source: CFTC Commitment of Traders data, Bloomberg. Prepared by David Rodriguez

The important technical shift has likewise coincided with a sharp turn in sentiment. CFTC Commitment of Traders data shows Net Non-Commercial futures positioning is now sharply net-short the USD/JPY (long JPY futures)—a dramatic move from only a year ago when the opposite was true. Large speculators are positioned for continued USD/JPY weakness, and the severity of the shift underlines the extent to which traders believe the pair will continue lower. – DR