29.12.202110:22 Forex Analysis & Reviews: Growing inflationary expectations is putting pressure on the Fed and supporting the US dollar. Overview of USD, CAD, and JPY

The slight wave of optimism associated with a decline in the expected risks from the spread of Omicron faded quite quickly. On Tuesday, US stock indices stopped growing, yields slightly pulled back, and stock exchanges of China and Japan are traded in the red zone. Meanwhile, the price of oil continues to rise – Brent has already tried to settle above $ 79 per barrel, which failed, but this is not enough to support demand for risk. Commodity currencies are showing attempts to turn down on Wednesday morning.

The US dollar remains the main favorite in the market. Inflation expectations slowed down a bit after record inflation in November, but after the Christmas holidays, yields on 5-year inflation-protected TIPS bonds began to rise again. This means that inflationary expectations remain high.

According to the St. Louis Fed, the break-even rate of 10-year bonds remained near the highs since December 8. The expected annual inflation rate according to the Cleveland Fed as of December 6 was 2.46%, and yesterday, it rose to 2.62%. The dynamics are in favor of the fact that inflation will continue to grow, which means that the Fed will be forced to maintain hawkish rhetoric, which ultimately makes the US dollar a market favorite.

USD/CAD

The Canadian economy looks confident – GDP rose by 0.8% in October and by 0.3% in November, which is less than October. On the other hand, the impact of the new COVD-19 strain on the economy in December is also unclear (for example, Scotiabank is inclined to consider this impact insignificant). The consolidated forecast is that growth in Q4 will be about the same as in Q3, with an overall annual growth of 4.5%, which, combined with a fast recovery in the labor market and high inflation, will give the Bank of Canada grounds for further curtailing incentives and rate increases.

The USD/CAD pair made a slight downward pullback, which was expected amid rising oil and overall demand for risk, but in general, the picture remains bullish. The target price is holding above the long-term average. Meanwhile, the CFTC report on the Canadian dollar was negative and showed a slight increase in the net short position, so investors do not see prospects for strengthening the currency for at least two or three coming weeks.

A pullback to the 1.28 mark will most likely be used to resume buying. The target remains the same – a consolidation above the resistance level of 1.2940, which failed on the first try, then a movement to 1.3015. This can happen in the first days after New Year.

USD/JPY

Japan's economy was hit by the coronavirus quite hard, with Q3 GDP 6% below Q3 2019. This was the second-worst among developed economies. Moreover, private consumption is 8% below normal levels, hence spending is low, and reasons for a quick recovery in GDP growth are weak.

Unlike most of the world's economies, Japan continues to balance on the edge of falling into deflation. Despite the fact that both the Bank of Japan and the government have taken unprecedented measures of support, consumption and investment in business remain at low levels. With such a dynamic in inflation, it is not necessary to count on withdrawal from support programs.

The Bank of Japan will take additional measures to prevent the yen from rising, as additional pressure on exporters will mean additional pressure on the economy as a whole.

The USD/JPY pair continues to develop a bullish momentum in the short term, while the demand for risk is being implemented. The target price is trying to move above the long-term average, which gives more reasons to further rise.

The growing demand for risk in the last pre-New Year days contributes to the yen's weakening. It can be assumed that the local high of 115.54 will be updated. The target is set at 118.60. The probability of a downward reversal has become noticeably lower.