USD/JPY Weekly Forecast: Inflation returns with a vengeance

• US CPI surprise reverses decline in Treasury rates.
• USD/JPY rises a figure as US inflation far outstrips forecasts.
• BOJ’s Kuroda warns of continued economic weakness.
• Federal Reserve thinks monetary policy should remain unchanged.
• FXStreet Forecast Poll predicts lower USD/JPY through the second quarter.

The US dollar has been beholden to the bond market all year. 

Wednesday’s inflation-fostered run in Treasury interest rates, though well within this year’s range, was sufficient to give the USD/JPY its best session since early last November.  

Dollar yen opened at 108.62 and was trading at 108.76 at the release of the US Consumer Price Index (CPI) for April.

The annual price gain was the attention getter. At 4.2% the increase was 0.6% over the 3.6% consensus forecast and a 1.6% jump on the March rate of 2.6%. 

In the first three hours after the Census Bureau data the USD/JPY rose almost a big figure reaching 109.54, its highest trade in a month. The pair finished the day at 109.67 the highest close since April 9. 

Consumer inflation in the US has tripled in four months from 1.4% in January and its impact is being felt across a wide range of goods. Wages are rising as employers try to entice workers back to their jobs. Markets had anticipated a sharp increase in annual inflation as the base effects of last year’s lockdowns work through the data. With commodity prices soaring and raw material and component shortages spreading, traders were suspicious that more than just statistical variation was at work. That suspicion has been confirmed. 

Treasury rates rose sharply after the CPI release. The benchmark 10-year yield bolted 7 basis points from 1.625% to 1.695%, the 5-year and the 30-year added 6 points each to 0.864% and 2.415% respectively. 

Only the 2-year, pinned by the Federal Reserve’s $120 billion a month of bond purchases, moved less than a point from 0.163% to 0.167%. 

US 10-year Treasury yield

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Treasury rates gave back some of their gains on Thursday, the 10-year lost just under 3 basis points to 1.668%, and continued lower on Friday. The USD/JPY followed the credit lead dropping to 109.48 on Thursday and trading down to 109.36 in early action on Friday. 

American Retail Sales for April on Friday were disappointing, coming in flat on expectations for a 1% increase, though March regained almost the difference as it was revised up to 10.7% from 9.8%. The Control Group slipped 1.5% in April. The forecast was for a 0.2% loss. March’s result was revised substantially higher to 7.6% from 6.9%. 

Japanese data had little market impact.

April’s Eco Watchers Survey in Outlook and Current were considerably weaker than expected, demoting the prospects for a domestic recovery. 

Bank of Japan Governor Haruhiko Kuroda did the yen no favors when he warned of the continuing impact of the pandemic in Japan, pledging to maintain the bank’s accommodative monetary policy. 

"Economic activity will remain below pre-pandemic levels for the time being," Kuroda said. "Risks to the economic outlook are skewed to the downside." 

Japan’s economy probably contracted in the first quarter with any rebound in the second expected to be modest given the new pandemic curbs on activity that will limit consumption. First-quarter GDP will be reported on May 17.

USD/JPY outlook

The tie to US interest rates remains paramount for the USD/JPY. Any appreciable move higher or lower in Treasury yields will be reflected in the pair. 

The Federal Reserve continues to insist that no policy change is warranted. despite the rapid advance of price indexes. 

"We're still a long way from our goals, and in our new framework, we want to see actual progress and not just forecast progress," said Vice Chairman Richard Clarida in a CNBC interview.

Despite the Federal Reserve’s repeated assertion that the surge in consumer inflation is a temporary phenomenon, the combination of wage pressures, material shortages and consumer demand, is ominous and not about to dissipate soon. 

Like the Fed, markets are interested in the actual performance of the US economy.

Inflation has returned to center stage. The forward-looking Producer Price Index for April, as CPI, was much stronger than suspected at 6.2%, and will keep the focus on price changes.

Japanese statistics are, somewhat unusually, more important in the week ahead than those of the US. First-quarter GDP on Monday is expected to show a 4.6% annualized contraction, anything worse will damage the yen. National CPI on Thursday is projected to show continued annual deflation, the greater the fall the more pressure on the BOJ for action and the lower the yen.

Technically, the USD/JPY is well supported at 109.35, the base of the head and shoulders pattern of late April to mid-March and then at intervals down to 108.50.

The contest in the USD/JPY is between the proof that the US economy and inflation are strengthening and their impact on US interest rates versus the tendency to slough-off when that evidence is lacking.

The bias is higher given the interest rate advantage of the US dollar, but the impetus is weak because of the uncertainty of US economic data. 

Japan statistics May 10–May 14

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US statistics May 10–May 14

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Japan statistics May 17–May 21

First quarter annualized GDP is most important with another of Japan's recurring contractions expected. National CPI is projected to be deflationary for the third month in a row. Neither statistic as forecast will help the yen. 

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US statistics May 17–May 21

The US housing market with information on building permits and starts on Tuesday and Existing Home Sales on Friday should continue red-hot.The scarcity of new homes, especially of lower-cost inventory is a major component of asset price inflation. 

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USD/JPY technical outlook

The rebound from the 38.2% Fibonacci level in late April remains the key technical limit. The USD/JPY has not closed below the 108.60 support since the April 27 recovery, and Wednesday's rise was abetted by its start at that important level. The immediate support line at 109.35 is the base of the head-and -shoulders formation from March 26 to April 12. First resistance at 109.70 is moderately strong, as it is based on several days trading. The others above are tenuous and would not block a fundamentally based move higher. 

The USD/JPY is likely to move sideways within a 108.60 -109.85 band until there is a disposition of the US inflation and growth picture, though weaker than expected Japan first quarter GDP could push the pair higher. 

The Relative Strength Index (RSI) at 56.61 is a buy signal. The 21-day moving average (MA) at 108.76 fronts support at 108.60. The 100-day MA at 106.90 and the 200-day at 105.96 are unimportant.

Resistance: 109.70, 109.85, 110.15, 110.35, 110.75

Support: 109.35, 109.00, 108.60, 107.90, 107.00

FXStreet Forecast Poll

The FXStreet Forecast Poll's uniformly bearish views are founded in an anticipated retracement of the Wednesday ascent. While that is a standard technical response, it is less applicable here given the fundamental nature of the recent gains.