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The USD/JPY pair has its own story to tell. Yesterday, the major currency pair stood out as the only dollar-based asset that did not collapse under the pressure of weak US inflation data but instead showed growth. So what is the reason behind this phenomenon, and what are the prospects for the dollar/yen pair?
USD holding steady
Persistent inflation that the United States has been grappling with for over a year is finally getting weaker. This was confirmed by the fresh data on the US consumer price index for May.
According to the report, core inflation increased by just 0.1% last month, and over the year, it demonstrated the slowest growth since March 2021, reaching 4.0%. It is worth noting that on a monthly basis, the change in consumer prices was 0.4% in April, while on a yearly basis, inflation stood at 4.9%.
As we can see, the progress is evident. Inflation in the US is retreating at a faster pace than expected. The May data turned out to be slightly weaker than economists' preliminary estimates, leaving traders with almost no doubts about the suspension of monetary tightening this month.
Currently, markets are assessing the likelihood that the Federal Reserve will refrain from raising interest rates for the 11th time in a row and maintain the benchmark rate at its current level, at around 93%. For comparison, prior to the release of the CPI release, the probability was 75%.
A significant weakening of hawkish sentiment in the market ahead of today's FOMC meeting led to a widespread decline in the dollar on Tuesday.
At the end of yesterday's trading session, the DXY index fell by 0.3% against its major rivals and reached a three-week low at 103.04.
The only exception among the major dollar-based assets was the USD/JPY pair. The instrument gained 0.4% and closed above the key level of 140.
The support for the dollar came from the strengthening of US Treasury yields. Yesterday, the yield sharply rose to 3.790% as traders considered the possibility of additional rate hikes in July.
At this stage, we cannot completely rule out this scenario because inflation is still far from the Fed's target of 2%. However, the stability of the core component of inflation should be of particular concern to Fed officials.
In May, the core CPI, which is considered the key metric for the regulator, remained at the same level as the previous month. This gives hope to dollar bulls who expect to hear a more hawkish statement from the Fed Chairman today.
Many analysts believe that the US dollar could strengthen across the board on Wednesday, even if the US central bank announces a pause. A boost for the USD could come from Jerome Powell hinting at continuing an aggressive policy and a shift in the Fed's dot plot towards tightening.
If both of these scenarios come true, the greenback is likely to show better dynamics against the yen, as the market will again be absorbed by speculation about further monetary divergence between the US and Japan.
Currently, the majority of investors believe that the Bank of Japan will maintain its ultra-low interest rates at its 2-day policy board meeting, which ends on Friday, June 16. Such a prospect acts as a tailwind for the USD/JPY pair.
Yen at risk of further decline
The Japanese currency started this year on a positive note as investors hoped that upcoming leadership changes at the BOJ would bring long-awaited changes to the country's monetary policy.
However, the new governor of the regulator, Kazuo Ueda, is in no hurry to normalize the monetary course. The official's recent comments indicate his intention to continue the ultra-loose monetary policy which includes negative interest rates.
Ueda's dovish stance has reignited last year's trend of the yen weakening. Since the beginning of the year, JPY has fallen by 6% against the dollar. Some experts believe that this is not the limit and see potential for further depreciation of the yen in the near future.
According to forecasts, by the end of the week, the USD/JPY pair may show parabolic growth if the Bank of Japan maintains the status quo.
According to a recent Bloomberg survey, over 50% of economists expect the BOJ to leave interest rates at -0.1% at the June meeting and keep them in this range until the end of the year.
This is a positive scenario for the USD/JPY pair, which will help it avoid significant losses even if the Federal Reserve sharply changes its monetary strategy.
According to Bloomberg analysts, the yen's bearish trend will also be supported by the further strengthening of the JPY's status as the most attractive currency for carry traders.
Currently, the yen is the only currency with a negative yield. Its funding cost with a 3-month rate stands at -0.4% compared to 30 other currencies analyzed by Bloomberg, whose yields are above zero.
"At this stage, this makes JPY the most preferred source of funding. We believe that the further increase in demand for carry trades will limit any strength in the yen," said Tsuyoshi Ueno, an economist at the NLI Research Institute.
The main risk for carry traders trading the yen at the moment is a spike in market volatility, which can negate profits.
However, the expected currency volatility index calculated by Deutsche Bank fell this week to its lowest level since February 2022, indicating a favorable volatility environment.
"There's a good potential for the carry trade especially when volatility drops," said Shusuke Yamada, head of Japan currency and rates strategy at Bank of America. "Market players are quite convinced that the low yield will continue in Japan for an extended period."
Technical outlook for USD/JPY
On the daily chart, the major currency pair is currently in a neutral position or slightly tilted upwards as it is trading above the daily exponential moving averages.
Bullish signals from the MACD indicator and an optimistic RSI line instill hope in buyers. However, for the uptrend to continue, the price needs to break above the 140.00 level and target the next resistance at the year's high of 140.91.
On the other hand, if the USD/JPY pair retreats and breaks below the 20-day EMA at 138.88, this will pave the way for the monthly low of 138.42.
In the event that the quote drops below 138.40, the 200-EMA support at 138.00 will act as the last line of defense for major buyers.
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