USD/JPY bulls are moving in as US stocks move off their highs

The market backdrop has turned increasingly risk-friendly over the past two days. The mood is reflecting some upside in growth indicators and the downside of inflation pressures. However, USD/JPY is back to being flat on the day following a move in the US dollar and yields that have shaken out some weak hands that have been positioned short in the greenback.

At the time of writing, USD/JPY is trading at 105.13 within the 104.646/105.461 day range. The markets are digesting the recent inflation data that has been released over two days, including Thursday's Producer Price Index.

The PPI echoed that of Wednesday's and embedded the hope that the Federal Reserve will be able to cool down price growth without shoving the economy into the deep freeze of recession. US stocks were higher in early trade on the fresh evidence of calming inflation but they have started to ease in midday trade as investors take profits and in the wake of a sell-off across the US dollar forex pairs with the 10-year yield rallying.

US stocks faded

On Wall Street, heading towards the final hour of trade, stocks have flipped over into negative territories as investors figure that the one-month data is not enough to start calling peak inflation. As a consequence, after adding more than 2% on Wednesday and rising more than 1% to a 3-month high earlier on Thursday, both the S&P and  Nasdaq turned negative.

At the time of writing, the 10-year yield is 3.41% higher on the day and has made a fresh high for the day of 2.902%. The move coincides with the 30-year bond auction. Meanwhile, the DXY, an index that measures the greenback vs. a basket of currencies is now back to near flat for the day at 105.14. The index has recovered from a low of 104.646.

July PPI month-over-month and year-over-year came in below expectations. In fact, the month-over-month reading was actually negative. Core readings were below the Reuters poll on a month-over-month basis and in-line on a year-over-year basis. The report lessened the prospects of the Fed up interest rates by 75 basis points for the third time in a row at the conclusion of its September policy meeting. Instead, CME Fed funds futures now predict a smaller 50 bp rate hike by nearly two to one.

Fed officials remain hawkish

Meanwhile, Fed officials spoke after the inflation data this week. For instance, following yesterday's CPI, Neel Kashkari unleashed his inner hawk and said the July CPI data did not change his expected rate path, though he was happy to see inflation surprise to the downside. Kashkari stressed that the Fed is far from declaring victory over inflation and stressed that recession “will not deter me” from getting to the 2% target. 

Today, Mary Daly, President of the San Francisco Fed did not rule out a third consecutive 0.75 percentage point rate rise at the central bank’s next policy meeting in September, although she signalled her initial support for the Fed to slow the pace of its interest rate increases, the Financial Times reported. "We have a lot of work to do. I just don’t want to do it so reactively that we find ourselves spoiling the labour market," the central banker said while also indicating that she would be watching the next consumer price and non-farm payroll reports to better calibrate her decision.

Commenting on the US dollar and in light of yesterday's CPI data, analysts at Brown Brothers Harriman said, ''we stress that there is a lot of noise right now even as markets remain thin during the summer months.'' 

''We are likely to continue seeing violent moves in the markets in the coming weeks as markets continue to struggle to find a stable and sustainable macro outlook to trade on. 

Recession? Soft landing? Tightening?  Easing?  All of these questions remain unanswered right now and we will not know the truth for months, if not quarters.''

Analysts at TD Securities argued that the recent downside miss of US core inflation underscores that we have likely seen the peak of inflation and perhaps the stagflation concerns. Even so, however, they ''don't think that risk assets are out of the woods yet, suggesting it could a bit more time to expect a persistent, positive boost in growth expectations and financial conditions.''

''A potential inflation peak (and associated end to Fed terminal rate price discovery) is an important ingredient to call the top in the USD. The other key (and arguably) more important ingredient is the outlook for global growth. On that factor, we don't think it is time to completely fade the USD, though the recent backdrop reductions convictions on USD long exposure,'' the analysts explained.