USD/JPY: Best week in months ahead of Fed and BoJ

• Japanese yen weakens amid an improvement in risk sentiment. 
• US Dollar manages to extend rally against Yen amid higher US yields. 
• After the European Central Bank meeting, attentions turn to the Federal Reserve and the Bank of Japan.

The USD/JPY rose on Friday for the fifth consecutive day. It peaked at 108.25 and the pulled back toward 108.00, holding to a weekly gain of near 125 pips, the best performance in months. US data and higher yields boosted the pair on Friday that kept rising despite technical indicators showing overbought extreme readings. 

The weekly chart shows USD/JPY heading for the first close above the 20-week moving average and posting the third gain in-a-row as the rally from 2-year lows continues. 

The improvement in risk sentiment, with hopes on US-China trade talks weakened further the demand for safe haven assets like the Yen, the Swiss Franc and Gold. Also a sharp rebound in US yields boosted USD/JPY. The 10-year climbed to 1.89%, the higher level since early August. The move took place ahead of a critical FOMC meeting. 

Eyes turn to central banks 

The Bank of Japan and the Federal Reserve will announce next week their decision on monetary policy. A rate cut from the Fed is expected while in Japan no change is seen. 

“Our view is that the Fed will cut rates by 25bp, as two out of the three important factors explaining the July cut (higher (trade) uncertainty, slower global growth and subdued inflation) have worsened since then (Trump escalated the trade war and data out of China and Europe have disappointed). While we do not think the Fed will pre-commit to further easing (although it will repeat its easing bias), we still expect four more cuts after the one next week, taking the target range to 0.75-1.00% at the March meeting”, said Danske Bank analysts. If the Fed delivers as expected, USD/JPY direction will likely depend on how more cuts the market sees afterwards. 

In Japan, no changes are seen in monetary policy. Analysts at TD Securities see not a major impact for the Japanese Yen from the meeting. “We expect USD/JPY to remain comfortably situated in a broad 107/109 range. The upper bound may bend as the positioning squeeze may intensify in the bond yield backup. The prevalence of the 200dma (currently at 109.43) is likely to offer firm resistance and a natural reassessment point on Yen weakness.”

Regarding BoJ, at TDS they consider it will eventually need to make a choice between salvaging its financial system or allowing the currency to adjust higher. “The JPY more generally remains one of the cheapest currencies in the G10 space according to our revamped BEER framework. We think as the BOJ prioritizes addressing the financial system, the adjustment in yields will force the JPY higher as capital flows reallocate and become more inward as the population ages.”