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USD/JPY is our featured pair thanks to the yen’s heightened volatility in recent times and as we have some key data from the US.

Welcome to another edition of the Currency Pair of the Week. The USD/JPY is among the major currency pairs to watch this week, thanks to the yen’s heightened volatility in recent times and the fact we have some key economic data from the US this week. 

• Yen drops as risk sentiment improves
• USD/JPY could resume lower on falling rates expectations
• Core PCE among key data releases to watch
   

USD/JPY bounces back as risk sentiment improves

The mood in the markets was noticeably brighter at the start of this week. Investors were hoping that authorities and regulators would be able to ring-fence stresses within the banking sector.  The USD/JPY and other yen pairs all bounced back, along with equity indices.

Sentiment towards risk actually improved in the second half of Friday’s session, and that momentum carried into the first half of Monday’s trading.

But there has been no fresh news, and so banks will remain under the spotlight. If we see any signs of fresh stress in the sector, then this should fuel a rally in the yen and undermine the USD/JPY pair.
 

What has been driving the USD/JPY lower recently?

The yen perceived by many as a haven currency has been strengthening across the board in recent weeks. Fears that the Deutsche Bank was on the edge of collapse sent haven assets soaring on Friday, which drove the USD/JPY momentarily below the 130.00 handle.

The yen has also been finding support from rising US and global bonds lately, reducing the gap between global yields and those of Japan. Fears of contagion within banks are what have been driving bond yields lower in recent weeks as investors sought safety in government debt and gold.

So, due to the stress in the banking sector and the not-so-hawkish remarks by central bank heads, the market has started to price in a pause in the global tightening race. In fact, fears grew so much last week that money markets priced in a quarter-point Fed rate cut by as early as June. While that may be a bit of an overreaction, it goes to show how quickly things can change.
 

USD/JPY could resume lower

We think there is a good chance the USD/JPY could resume trending lower again. As the market grows even more confident about the major central banks pausing their rate hiking and possibly even starting cutting interest rates in the not-too-distant future, this should keep a ceiling on bond yields and therefore the USD/JPY.

Bond prices may find renewed strength on the back of any fresh fears over banks or if we start to see more evidence of slowing global economic activity. After all, the impact of one of the fastest central bank tightening cycles has yet to fully filter through the economy. Meanwhile, the Bank of Japan never tightened its belt during these times of high inflation. So, there is not much loosening they can do when others eventually start cutting their interest rates. This is precisely why the yen has been supported so significantly in recent weeks and is exactly why we think the USD/JPY could be heading for a new low on the year, soon.
 

Key data that could impact USD/JPY this week

We have a wide range of US event risks, including consumer confidence and housing market data this week. But it is the Core PCE Price Index that is likely to garner most of the attention at the bank end of the week. Following the Fed’s policy decision last week, the market will be paying close attention to incoming inflation data in order to figure out whether more rate hikes will follow, or the Fed will hit the pause button. The Core PCE price index is the Fed’s preferred measure of inflation, so the market won’t take any surprise readings lightly.

Kuroda’s tenure ends this week

Meanwhile, Haruhiko Kuroda, who has been the Governor of the Bank of Japan since March 2013, will finish his tenure at the end of this week and will be replaced by Kazuo Ueda. We wouldn’t rule out the possibility that some investors might start buying the yen in anticipation of a potential change in the way the BoJ has been dealing with monetary policy. However, many market observers expect a gradual policy normalization under the central bank’s new leadership. Therefore, there may only be limited volatility because of the changeover.
 

USD/JPY technical analysis

(Click on image to enlarge)

After its sharp falls, the USD/JPY was always going to stage a bit of a recovery from the key 130.00 psychologically-important level. It fell below that level on Friday, but once it was reclaimed, the pair managed to keep pushing higher as the sellers abandoned their positions. As a result of the recovery, it printed a doji/hammer candle on the daily time frame. This bullish reversal candle has given the bulls some confidence that rates may have bottomed. Still, this group of market participants will certainly want to see some more bullish price action for confirmation.

Indeed, we wouldn’t put too much emphasis on just one candlestick pattern alone. The USD/JPY’s trend is clearly bearish given the lower highs and lower lows. So, it could reverse again, which is why it is important to watch your resistance levels closely.

One such zone is the shaded region on the chart around 131.55 to 132.30, which had been pivotal in the past. The bears will need to defend this area to keep the short-term trend bearish.

Meanwhile, on an intra-day basis, the bulls who bought on the back of Friday’s bullish-looking candle, will be in a spot of bother if the USD/JPY goes below today’s low at 130.50. Should that happen, then a move below Friday’s low could be the next downside target for the bears.

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