USD/JPY Forecast: Doji contradicts the drop in risk reversal

The Dollar-Yen pair dropped to a low of 108.71 on Friday after the weaker-than-expected US CPI release on Friday dented the odds of a Fed rate hike next year. However, the spot quickly recovered losses to end the day on a flat note at 109.17, give the curve between the 10-year Treasury yield and the 2-year Treasury yield actually steepened to 89.3 basis points from 87.6 basis points. The spread currently stands at 90 basis points. 

Having dipped to a low of 109.02, the pair currently trades around 109.48 levels. 

Factors in favor of further losses- 

• One-month 25-delta risk reversal

The one-month 25-delta risk reversal fell to -1.775 on Friday, continuing the steady decline of the recent high on -0.97. It indicates increased demand for Put option/downside bets. 

• Trend line support has been breached

Daily chart

The trend line sloping upwards from the April low and June low was breached to the downside on Thursday. It indicates the continuation of the sell-off from the high of 114.36. 

• Geopolitical tensions support further losses in the Dollar-Yen 

Inflation expectations seem to have topped out

The chart below shows, the 5-Year, 5-Year Forward Inflation Expectation Rate may have topped out around 2%. The US dollar cheers rising inflation expectations and vice versa. 

Factors in favor of a rebound- 

• Potential bullish reversal: A positive end of the day close today, preferably above 109.50 levels would credence to the Friday’s Doji candle and signal short-term trend reversal in favor of the bulls. 
• Yield curve has steepened: As mentioned earlier the spread between the US 10-yr yield and the 2-yr yield has steeped to 90 basis points, despite Friday’s weak inflation data. 

View:

It is a wait and watch game today. Confirmation of the bullish reversal would open doors for 111.00 handle, although falling risk reversal suggests the upticks are likely to be short lived. On the downside, support at 108.13 stands exposed.