USD/JPY still flirting with the 107.00 level as risk events loom

USD/JPY has been moving sideways in the 106.90s for the past few hours as it continues to flirt with the 107.00 level, unable to convincingly break back above to test session highs set shortly after the US open of 107.153. Volumes have died down now that North American market participants have left for the day, with volumes expected to pick up again over the next few hours as Asian market participants start their day. In the end, USD/JPY closed Wednesday FX trade with gains of 0.3% or just over 30 pips.

Driving the day

Rising US government bond yields gave tailwinds to USD/JPY on Wednesday; 10-year US government bond yields are up close to 7bps at the time of writing and above 1.48%. JPY is particularly sensitive to rate differentials with its G10 peers, given that Japanese government bonds all the way out to the 10-year are locked close to the 0.0% mark amid the BoJ’s ongoing Yield Curve Control policy, which is designed to keep the 10-year Japanese government bond yield close to zero.

Spill-over from a sell-off in UK bond markets post the unveiling of the UK budget (which included larger than expected spending and thus borrowing requirements) is being cited as pushing US yields higher on Wednesday, as is corporate supply and positioning ahead of comments from Fed Chair Jerome Powell on Tuesday. Meanwhile, Softer than expected ADP National Employment and ISM Services PMI data did little to dent the rally in bond yields, likely because 1) ADP has had weak predictive power for the official NFP number in recent months, so desks remain confident that NFP could still be strong and 2) the headline ISM number was still strong by historic standards and also contained further evidence of inflationary pressures (bullish for bond yields).

Potential Fed response to rising bond yields

Fed speak on Wednesday has for the most part not revealed anything new in terms of how Fed officials view the US economy, but Fed members have been talking much more openly about the kinds of policies they would like to see employed in order to curb rising bond yields, if things got “out of control”. Operation twist (where the Fed maintains the monthly pace of treasury purchases but increases the weighted average maturity of its bond purchases) and yield curve control (where the Fed sets a yield target and buys bonds in whatever quantity is necessary to keep yields below this level) are both being talked about. It seems as though Fed members would need to see a significant amount of further upside in US bond yields in order to justify these policies, however, hence why desks are calling for more Fed action only if 10-year yields rally to the 1.75%-2.0% region.

In terms of what the above means for USD/JPY; the more interventionist the Fed (i.e. the more eager the bank is to fight rising bond yields), the better worse for JPY, which likes higher US/Japan rate differentials. With the US economic outlook improving as the country’s economy reopens, the vaccine rollout accelerates and with more stimulus on the way, the path of least resistance for yields seems to point upwards, however, regardless of what the Fed says or does. Fed Chair Jerome Powell will be speaking to the WSJ on Thursday, with his remarks scheduled for release at 17:05GMT and traders will be on the lookout for more information regarding all of the topics discussed above.