USD/JPY bulls struggle at psychological 110 handle due to blockade in US bond market & Fed

USD/JPY shot up at the start of this month, reversing the FOMC sell-off as the markets figured that divergence remains between the Fed and central banks despite their recent switch to neutral,( Fed officials have shifted strongly to a patient), while the US economy stands on stronger foundations than rival economies.

The US data has also proven robust

The nonfarm payrolls posted a second consecutive blockbuster gain of 304k, smashing expectations for a revert to 165k. However, USD/JPY is closely correlated to the stock and bond markets. This is why the US/JP spread is so key to USD/JPY-FX. 

While the data was solid,  the weaker than expected wage print left rates relatively contained in the immediate response to the report. We did see some upside in the US 10 year yields at the start of the month, but that may have been more in response to the ISM data. The US national ISM  manufacturing PMI survey staged an impressive recovery in January, rising to 56.6 from 54.3, led by gains in both the new orders and production sub-indices, with both returning to levels well above long-run averages. However, today's services were less than impressive which will weigh the dollar's progress:

• US: Markit Services PMI falls to 54.2 in January from 54.4 in December
• US: ISM Non-Manufacturing PMI drops to 56.7 in January vs 57.2 expected

US yields a major player

The US 10yr treasury yield rebounded off a one-month low of 2.62% to 2.69% while the 2yr yields rose from 2.46% to 2.52%. However, yields have hit a roadblock here, with the benchmark 10-year yield topping out at a prior 23.6% Fibo resistance/support level of the 3rd Jan bottom of 2.5440% - 2.799% located at 2.7380%. If futures markets continue to price no chance of any further Fed rate hikes in this cycle, then it is going to be a tough environment for yields to rise should growth fears trickle into the picture again. 

Having said that,  Sino/US relations are seen to be making progress on trade and there is little sign that U.S. stocks are about to stumble on to the back foot again; They have had their best start in January for decades and bulls remain in control. 

However, USD/JPY is struggling at this juncture with the slide in yields ahead of President Donald Trump who due to address the Congress with his 2019 State of the Union Speech on Tuesday where markets are getting positioned for comments on trade and the broader U.S. economy. 

How dismal is the outlook for the dollar?

All in all, the outlook for the dollar may not be so negative than investors first figured following the sudden switch u at the Fed and on that basis, we have seen USD/JPY make a slight erosion of the 110.000 resistance. However, repeated failures through 110 the figure could be a telling sign that the dollar's upside potential is limited, across the board. 

Analysts at TD Securities argued that the strength of the DXY masks the weakness in the other dollars, especially as high-beta currencies look well supported:

"USDCNH continues to hold 6.8 and USDJPY failed to break 110. The improvement in liquidity and financial conditions underscore the room for a deeper correction in the USD versus the high-beta complex."

With respect to the impressive Nonfarm payrolls data, the pessimism continued to flow at TD Securities:

"On balance, we look through this report and place greater emphasis on leading growth indicators like the ISM surveys. We retain our sell on rallies posture in USDJPY as a hedge to bullish high beta FX views."

USD/JPY levels

Analysts at Commerzbank explained that:

"The Elliott wave count continues to say that this move is corrective only, the DMI is negative...The chart remains negative but currently is grinding higher. The market is contained higher in a channel and the top of this is located at 110.51. We are currently in no man’s land sitting below the 200 day ma and the October low at 111.26/41. The base of the channel at 108.64 guards the 107.75/50 band."