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The USD/JPY continued to march on towards its June high of 145.00 after the initial dollar selling was bought in the aftermath of the inflation data.

Dollar regains poise after CPI-inspired drop

Following the release of US CPI, the US dollar initially sold off, while equities and gold rallied. But the small beat on the headline front wasn’t enough to cause a complete reversal in the trend. So, once the dust settled, the dollar found renewed support with the likes of the GBP/USD and EUR/USD giving back big chunks of their earlier gains, while gold relinquished its entire CPI-inspired gains. All told, CPI didn’t cause any significant change in the dollar’s ongoing trend. But we doubt the greenback has much fuel left in the tank. So, watch out for a correction soon – although the USD/JPY is probably not the best pair to take advantage of a potential dollar reversal, due to the fact the BoJ’s policy is extremely loose compared to other central banks.

Can US inflation remain elevated?

There are some concerns that while US CPI inflation is moderating, there are some signs that it could heat up again. Falling energy prices has been a big contributor behind the recent declines in inflation. But with WTI oil prices nearing $85, pushing up gasoline prices, this could prevent CPI falling back to the Fed’s target, forcing the central bank to maintain a restrictive policy for longer. So, I do think that energy and wage inflation in the services sector will keep the headline rate elevated.

But this will be offset by China exporting disinflation, where consumer prices have moved into the deflation territory. So, the most likely outcome is that price pressures will generally move lower but at a much slower pace than in recent months. 

The Fed will feel that it has already done enough to bring inflation towards its 2% target in the medium term. What’s more, global monetary policy is quite restrictive if you look at the developed economies. As a result, I think inflation will move further lower over time, and the Fed will start to loosen its belt next year rather than tighten it further this year.

For that reason, the US dollar could soon start trending lower again, boosting the appeal of some dollar-denominated assets. But we do need to see a clear reversal pattern before turning bearish on the dollar. Until that happens, the dollar bears should proceed with extra care.

UoM surveys up next

Until the Fed’s next meeting in September, we will have one more inflation and jobs report. Any further weakening of CPI could cement expectations of a policy hold. But the Fed will also monitor other macro indicators, including consumer confidence. On Friday, we will have the latest reading on the University of Michigan’s Consumer Sentiment and Inflation Expectations surveys to look forward to.

But if most of these indicators point to continued strength in the US economy, then this should keep the dollar supported on the dips against the yen, which continues to fall out of favour because of the BoJ’s ongoing ultra-loose policy stance.

USD/JPY analysis: no change in current trend yet

The USD/JPY is continuing to make higher highs. With prior resistance at 143.50 turning into support, the path of least resistance continues to be to the upside, with the bulls eying the June high of 150.00 as their net target. If we get above 145.00 then this would likely increase the risk of fresh intervention by the BoJ. A move back below 143.50 is what the bears would like to see as minimum before potentially looking for any bearish trades, given that almost all the indicators on the chart look bullish. For example, price is still above the 21-day exponential average, which means the near-term trend is objectively bullish.

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Source: TradingView.com

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