USD/JPY Forecast: Bull-Bear tug of war, focus on key trend line levels

The bearish move in the Dollar-Yen pair was cut short at 111.65 (Monday's low) as talk of a more hawkish Fed head put a bid under the US dollar. The record run in the US stocks also kept the funding currencies (Yen) under pressure.

However, the rebound from the low of 111.65 appears to have run out of steam near 112.50 as suggested by Tuesday's Doji candle.

Tug of war

Factors that strengthen the USD bulls/JPY bears:

• Record highs in US stocks
• Talk of hawkish Fed head
• Uptick in the Chinese PPI (reflation story positive for risk assets, negative for funding currencies)

Factors that work in favor of the USD bears/JPY bulls:

• US 10-year treasury yield failed to take out 2.4%, hovers near 2.3%
• The Fed Dec rate hike has been priced-in. The Fed-speak has put the focus back on inflation, thus markets fear the central bank may backtrack from its September view of three rate hikes in 2018 if inflation remains weak.
• The Treasury yield curve continues to flatten (the difference between the US 10-year yield and the US 2-year yield) stands at 74.8 basis points (flattest since August 2016). A flatter yield curve is USD bearish and vice versa.
• Uncertainty ahead of Japanese elections (Abe's rival party Kibō no Tō has said it would work with BOJ on the exit strategy. The strong performance of Kibō no Tō is seen strengthening Yen)

The direction of the breakout depends on which side gives-in first. The key trendline levels plotted on the weekly chart below show a bigger falling tops formation (bearish) is still intact. (Read - USD/JPY Forecast: Monthly chart looks super bullish)

Weekly chart

The above chart shows:

• Three downward sloping trend lines (6, 1, 2, 4)
• Channel formation marked by blue lines (3, 5)

Currently, the spot is chipping away the resistance offered by the trendline (1). The rally from the September low of 107.32 ran out of steam two weeks back above the trend line (1).

A break below 111.40 - support offered by trend line (2) would open doors for 110.30 (channel support) and 110.00 levels.

On the higher side, a move above last week's high of 112.83 could see the spot test supply around 113.75 - resistance offered by trendline (4).

On a larger scheme of things, only a break above 114.45 - resistance offered by trend line (6) would signal a continuation of the rally from the September 2 low of 107.32.