USD/JPY Forecast: Yield differential isn't backing the USD's rebound from two-week lows

USD/JPY's rebound from the two-week low of 110.36 to 110.22, though encouraging, looks unsustainable if we take into account the falling 10-year US-Japan yield differential.

At press time, the currency pair is trading at a session low of 109.90, having clocked a high of 110.20 earlier today.  

The pair's failure to beat the 200-day MA of 110.19 isn't surprising, given the US-Japan yield spread is losing altitude in the USD-negative manner.

The spread or the difference between the 10-year US treasury yield and the 10-year Japanese Government bond yield has dropped to 285 basis points (bps) today - down eight basis points from the current month's high of 293 bps and 20 bps from the post-GFC peak of 305 bps seen in May.

The falling yield spread puts a question mark on the sustainability of USD's rebound from 109.36 to 110.22.

Further, it appears the yield spread is creating a head-and-shoulders bearish reversal pattern with the neckline support of 2.75 percent, as seen in the chart below.

Yield spread

Acceptance below 2.75 percent would confirm a head-and-shoulders breakdown and would open up downside towards 245 basis points. In this case, the USD bears will likely make a strong comeback.

Also, technically speaking, the outlook remains bearish while the trendline sloping downwards from August 2015 high and December 2015 high is intact.

Monthly chart

The above chart also shows the pair is struggling to find acceptance above the long-term rising trendline, having breached it in a convincing manner in February 2018. The repeated failure to beat the rising trendline resistance only adds credence to the bearish picture painted by the deflating 10-year US-Japan yield spread.

Only a convincing move above the long-term falling trendline would confirm a bullish reversal.

Daily chart

A daily close below the 109.67 (50-day MA + rising trendline) would signal the rally from the March 26 low of 104.63 has ended and will likely allow a drop to 108.82 (38.2 percent Fibonacci retracement of 104.63-111.40).

View

USD/JPY rally seen in the last 24 hours could be a bull trap as indicated by the narrowing US-Japan yield spread. 

The path of least resistance is to the downside. A daily close below the confluence of the rising trendline and 50-day MA would open doors for a deeper pullback to 108.81. 

The overall outlook remains bearish while the long-term falling trendline (drawn from August 2015 high) is intact.