USD/JPY Forecast: Bullish potential intact despite the overnight post-US CPI slump

  • USD/JPY came under intense selling pressure on Wednesday and tumbled to over a one-week low.
  • Softer US CPI report dashed hopes for aggressive Fed rate hikes and weighed heavily on the USD.
  • The risk-on impulse, the Fed-BoJ policy divergence undermined the JPY and limited further losses.

The USD/JPY pair continued with its struggle to decisively break through the 50-day SMA and witnessed a dramatic turnaround on Wednesday, plunging over 300 pips intraday. The steep fall followed the release of softer US consumer inflation figures, which triggered aggressive US dollar selling. In fact, the headline US CPI decelerated more than anticipated, to the 8.5% YoY rate in July from 9.1% in the previous month. Adding to this, the core CPI, which excludes food and energy prices, held steady at the 5.9% YoY rate during the reported month, missing estimates for a reading of 6.1%.

The data forced investors to scale back expectations for a larger 75 bps rate hike move by the Fed in September and was evident from a sharp decline in the US Treasury bond yields. This resulted in the narrowing of the US-Japan yield differential, which boosted the Japanese yen and further contributed to the USD/JPY pair’s overnight slump. That said, the risk-on impulse capped gains for the safe-haven JPY. This, along with hawkish comments by several Fed officials, assisted the major to defend the 132.00 round-figure mark and stage a goodish bounce of around 85 pips from the daily low.

St. Louis Fed President James Bullard said that it was too early to claim inflation has peaked and still wants interest rates to get to the 3.75%-4.00% range by the end of the year. Separately, Chicago Fed President Charles Evans noted that inflation is still unacceptably high and expects Fed to continue to raise the interest rate to 3.25%-3.50% by year-end, and 3.75%-4.00% by the end of next year. Adding to this, Minneapolis Fed President Neel Kashkari said that the Fed is far away from declaring victory on inflation and recommended the rate at 3.9% by the end of this year in the June economic projections.

Nevertheless, the Fed is still expected to hike interest rates by at least 50 bps at the September policy meeting. In contrast, the Bank of Japan has repeatedly said that it will stick to its ultra-easy policy settings, marking a big divergence in comparison to a more hawkish stance adopted by the US central bank. This, along with a strong recovery in the US bond yields and the emergence of some USD buying, allowed the USD/JPY pair to climb back above the 133.00 mark during the Asian session on Thursday. Traders now look forward to the release of the US Producer Price Index (PPI) for some impetus.

Technical Outlook

From a technical perspective, any subsequent move up is likely to confront some resistance near the 133.35 region ahead of the 133.80-133.85 area. This is closely followed by the 134.00 round figure and the 134.30 resistance zone. Some follow-through buying should pave the way for a move back towards reclaiming the 135.00 psychological mark en route to the 50-day SMA strong barrier, currently around the 135.20-135.25 region. The latter should act as a key pivotal point, which if cleared decisively would be seen as a fresh trigger for bullish traders and set the stage for a further near-term appreciating move towards the 136.00 round-figure mark.

On the flip side, the 132.60 area now seems to protect the immediate downside, below which the USD/JPY pair could slide back towards the overnight swing low, around the 132.00 mark. Any further decline, however, should pause near the 131.50-40 strong horizontal resistance breakpoint, now turned support. The next relevant support is pegged near the 100-day SMA, currently around the 131.20 region, which if broken decisively might prompt aggressive technical selling. The USD/JPY pair would then turn vulnerable to weaken further below the 131.00 mark and accelerate the fall towards the monthly swing low, around the 130.40-130.35 region.

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