USD/JPY Forecast: Long-term bull breakout likely if the Fed projects higher neutral rate

The USD/JPY pair looks north, having crossed the 200-day moving average in a convincing manner yesterday, however, only an upward revision of "neutral interest rate" by the Fed would open the doors for a break above the long-term descending trendline.

As of writing, the currency pair is trading at 110.48. The spot closed above the 200-day moving average (MA) of 110.18 yesterday, putting the bulls back into the driver's seat.

Daily chart

A move above the 200-day MA adds credence to the rebound from the bullish (ascending) 50-day MA and has established a higher low and higher high pattern.

The moving averages are biased bullish - 5,10-day MA are trending north, indicating bullish setup. The 14-day relative strength index (RSI) also favors the bulls (holds above 50.00).

Weekly chart

The spot seems to have found acceptance above the 50-week MA of 110.21. Further, The 5-week and 10-week MAs are sloping upwards, indicating a bullish setup. The 14-week RSI is trending north in favor of the bulls.

So, a move above the recent high of 111.40 and a rally to 111.95 (long-term falling trendline) looks like a done deal.

That said, a long-run bull breakout, i.e. an aggressive move above 111.95 could remain elusive unless the Fed revises the neutral rate forecast.

What is neutral rate?

The neutral rate is the rate which is neither boosting nor tightening economic conditions. The Fed pushed up its estimate of the long-run neutral interest rates to 2.9% from 2.8% in December. Also, the Fed sees interest rate at  3.4 percent by the end of 2020.

Fed preview: A drift up in dots or hint of raising rates beyond neutral would be seen as hawkish

A 25 basis point rate hike has been baked-in and the 2018 median dot is expected to remain at three hikes.

USD/JPY bull trap scenario: hikes rates + hints at faster rate hikes + keeps neutral rate forecast unchanged at 3 percent.

The greenback could pick up a bid, but the resulting rally in USD/JPY will likely fall short of 111.95 and could be short-lived as faster Fed rate hikes and no change in the neutral rate forecast would mean the Fed is nearing an end of policy tightening sooner-than-expected.

USD/JPY bull breakout scenario: Hikes rates + drift up in dots or upward revision of neutral rate + faster Fed rate hikes

The pair could take out 111.95 in a convincing manner, signaling a long-run bearish-to-bullish trend change if the Fed pushes up the neutral rate forecast and hints at a total of four interest rate hikes in 2018.

USD bearish scenario: Hikes rates + downward revision of neutral rate forecast + slower rate hikes

In this case, the US-Japan bond yield differential could drop sharply in the JPY positive manner. Hence, the pair could resume its journey back to 107.32 (September 2017 low).