USD/JPY Forecast: Below-forecast US CPI could yield rising channel breakdown

The USD/JPY is on the defensive, having hit three-week lows earlier today and could drop below the rising channel support on weaker-than-expected US inflation and risk aversion in the stocks.

The JPY picked up a bid as the Dow Jones Industrial Average plunged more than 800 points Wednesday. As discussed last week, fast-rising bond yields are weighing over equities and pushing the USD/JPY lower.

The currency pair fell to 112.06 a few minutes before press time - the lowest level since Sept. 20 - and was last seen trading at 112.27.

As seen in the chart below, the drop to three-week lows has neutralized the immediate bullish outlook.

Daily chart

The currency pair closed below the support of the previous cyclical high of 113.18 yesterday, adding credence to the bearish crossover on the MACD and the negative crossover between the 5-day and 10-day exponential moving averages (EMAs). The sell-off also pushed the 14-day relative strength index (RSI) in bearish territory below 50.00.

However, all is not lost for the USD bulls...

Long-term MAS are biased bullish: The 50-day, 100-day, and 200-day EMAs are still trending north and the stacking order of the 50-day above the 100-day, above the 200-day EMA, indicates the path of least resistance is on the higher side.

More importantly, the pair has charted higher lows along these averages since June and history could be repeating itself - the currency pair has bounced off the ascending 50-day EMA in Asia.

Rising channel is intact: As seen in the weekly chart below, the rising channel is still intact and only a close below the lower edge of the channel, currently seen at 111.57, would abort the bullish view put forward by the pennant breakout, confirmed in September.

Above-forecast US CPI could boost demand for USD: September’s CPI is expected to grow by 0.2% month-on-month, the same as in August. This would put the annualized reading at a six-month low of 2.4%. An above-forecast reading could push up the 10-year treasury yield, helping the USD/JPY pair stage a solid rebound from the 50-day EMA support.

It is worth noting that the Fed's preferred measure of inflation - the core PCE -  stood at 2 percent year-on-year for the fourth-straight month in August. As a result, below-forecast CPI may not derail Fed rate hike plans but would validate the argument put forward by Fed's Kaplan that inflation is unlikely to get out of hand and the bank may not need to push rates above neutral. Hence, the pair could drop to rising channel support of 111.57 if the CPI and core CPI prints below estimates and the stocks remain on the back foot.