USD/JPY Forecast: Eyes descending trend line support, what’s hurting the US dollar?

The Dollar-Yen pair fell from the high of 113.46 to 112.55 levels on Thursday as the offered tone around the US dollar strengthened on the back of a slide in the treasury yields.

The initial jobless claims ticked up slightly to 244K from 238K. The Chicago Fed national activity index and Kansas City Fed manufacturing index were both much softer than expected with the Chicago index falling to -0.05 from 0.18, and the KC Fed index dropping to 11 from January's 20.

Here is why the markets sold the US dollars -

Market dependent Fed - Fed’s Mester, while speaking to Bloomberg earlier this week, said the Fed does not want to do anything that would surprise the markets. This essentially means the Fed remains market-dependent and would not hike rates unless rate hike bets move at least above 60%. Mester’s comments disappointed dollar bulls, who had positioned for a much more reactive Fed in 2017.

Ambiguous language of Fed minutes - “How soon is fairly soon”. Despite rising inflationary pressures and record rally in stocks, the Fed minutes carried the usual confusing language on the timing of the next rate hike. Yellen said in her testimony earlier this month that the Fed’s interest rate projections are not dependent on fiscal policy. Still, the minutes carried the confusing/cautious tone.

Trump wants a weaker dollar to help exporters - While talking to Caterpillar chairman and former CEO Doug Oberhelman, President Trump talked about the need for level playing field i.e. a weaker USD in line with the competitive devaluation by other countries. The manufacturing employment in the US has steadily dropped over the last 40 years and if Trump intends to import jobs back to America, a weaker dollar is a necessity.

Treasury yields drop - The 10-year Treasury yield has dropped from 2.52% to 2.37% over the last one week or so. One may argue that the drop actually represents increased demand for the treasuries (and USD) due to political uncertainty in Europe and yield differential. However, the Dollar-Yen has strong correlation with the 10-yr yield, thus the decline in the exchange rate is not surprising.

Dollar Index - Head and Shoulder pattern

The reversal pattern on the Dollar Index coupled with the bearish macro points discussed above suggests the Dollar-Yen pair continue losing height over the next week.

USD/JPY Technicals - Eyes 111.80

Daily chart

• Last Friday’s rebound from the descending trend line support ran out of steam at 114.96.
• The pair’s retreat from the high of 113.73 has established falling tops formation.
• A break below 112.60 would open doors for a sell-off to the descending trend line support seen today around 111.80 levels.
• On the higher side, only a daily close above 114.96 would abort the bearish view.
• The overall price action suggests a decline to 111.80 is more likely than not.