USD/JPY meets strong resistance near 137.00, but bulls eye 138.00

USD/JPY has been flat in Asia so far, tucked in below 137.00 having traded between 136.84 and 137.02 as traders contemplate the recessionary fears in financial markets following a sea of red in global equities on Tuesday. 

US Treasury yield curve signals US recession 

MSCI's all-country world index, a gauge of stock performance in 47 countries, dropped 1.26% to mark its third down day in a row after hitting a three-month high last week. The US dollar rose on Tuesday as the market weighed how long the Federal Reserve would keep interest rates high.

US Treasury yields also fell, but more at the long end of maturities than the short end. This is a strong indication that a recession is on the cards as the yield curve has deepened with the gap between yields on two- and 10-year notes at -83.7 basis points. Consequently, risk sentiment deteriorated as markets weighed up the economic impacts of a possible recession in 2023. The 2-year government bond yields were 3bps lower, ending at 4.36%, and 10-year government bond yields fell 5bps to 3.52%. 

Improved US economic data sparks risk-off

The Institute for Supply Management (ISM) said its Non-Manufacturing PMI rose to 56.5 last month from 54.4 in October, indicating that the services sector, which accounts for more than two-thirds of US economic activity, remained resilient in the face of rising interest rates.

The data beat forecast the Non-manufacturing PMI would fall to 53.1. While the data combined with last Friday's surprisingly strong Nonfarm Payrolls data in November had raised optimism that a recession could be avoided in 2023, investors are concerned that the Fed will subsequently hike rates by 75 Bps again at the December meeting. 

Eyes on the Federal Reserve

After Powell’s speech last week, the narrative swung towards dovish.  After Average Hourly Earnings and Services PMI, that narrative is moving swiftly back to hawkish and this is supportive of the US Dollar. 

''We imagine there will be some whispers about 75 bp from the Fed next week but we think it will depend in large part on the CPI data out the day before the decision,'' analysts at Brown Brothers Harriman said.

''That said, we think it was a mistake for Powell to take 75 bp off the table last week. World Interest Rate Probabilities, (WIRP) still suggests that a 50 bp hike on December 14 is fully priced in, with only 5% odds of a larger 75 bp move.  The swaps market is pricing in a peak policy rate of 5.0% but odds of a higher 5.25% peak have crept back in,'' the analysts added.

However, hawkishly, the analysts at BBH say that they ''don't think two more 50 bp hikes will do it, not when the labour market remains so firm and consumption is holding up.'' The analysts argue that getting core Personal Consumption Expenditures (PCE) back down to the Fed’s target of 2% will be much more difficult than markets are pricing in.  

USD/JPY technical analysis

USD/JPY is meeting a potential resistance area on the daily chart as the bulls move in on the 137.00s. If these were to hold, USD/JPY could face supply that may lead to a downside extension. On the flip side, a move in USD/JPY beyond the trendlines and 138.00 will leave the scope for a significant bullish correction with 140.00 and beyond eyed.