USD/JPY Hits Two-Decade Highs as US Yields Roar

USD/JPY OUTLOOK:

• USD/JPY soars to two-decade highs as U.S. yields charge higher
• The dollar may continue to strengthen if U.S. May inflation data surprise to the upside and boost calls for more aggressive Fed tightening
• Japan’s government is unlikely to intervene to support the Japanese yen at this time, but if disorderly moves persist, this scenario should not be ruled out

USD/JPY spent much of May on a downward path, falling from a high of 131.35 to a low of 126.35, dented by the pullback in U.S. government rates. However, the correction in the U.S. dollar was short-lived, with the pair resuming its explosive rise this month, reaching a two-decade high of 134.47 today after posting solid gains over the past four sessions.

The rally in the last several days has coincided with the rebound in U.S. yields, which has been sparked by a reassessment of the Fed’s monetary policy outlook (both the 2-year and 10-year yield are back near their cycle’s high). For instance, markets had expected the FOMC to front-load rate hikes in 50 bps increments only at its May, June, and July meeting, but bets are increasing that the bank could continue to tighten at this pace through September amid persistently elevated price pressures in the American economy.

Although headline inflation may have topped out during the first quarter at 8.5%, its convergence toward the Fed’s 2% target will be extremely slow. In fact, soaring energy costs could prevent any meaningful improvement in the trend in the coming months, leaving policymakers with no choice but to press ahead with super-sized half a percentage point interest rate increases in all remaining conclaves in 2022, and only return to the standard 25 bps adjustments in 2023.

We will get a better picture of the inflation situation on Friday, when the U.S. Bureau of Labor Statistics releases its May Consumer Price Index. Analysts polled by Bloomberg News expect headline CPI to advance 0.7% m-o-m and 8.3% y-o-y, though the results could easily surprise to the upside given recent developments in the fuel market (gas + diesel at the pump surging). If numbers blow past forecasts, U.S. Treasury yields could reprice significantly higher on bets of accelerated hikes to neutral, widening differentials with Japanese rates, a situation that will bolster the greenback.

In the current environment, the Japanese yen is likely to remain subdued against the U.S. dollar over the next days and weeks. Perhaps the only possibility for a substantial USD/JPY bearish reversal would be foreign exchange intervention by the Japanese government.

Japan's Finance Minister Shuichi Suzuki has indicated that he is watching the currency market with a sense of urgency, but has not shown a strong willingness to intervene to stem the yen's slide. However, if disorderly moves persist, we could see measures aimed at shoring up the Asian currency ahead of key national elections in the coming months. For the time being, traders will be well served by keeping a close eye on the Japanese government's intervention comments.

USD/JPY TECHNICAL ANALYSIS

The U.S. dollar rallied for four straight days against the yen and briefly hit a twenty-year high near 134.50 on Wednesday. While USD/JPY continues to have a bullish bias, the monthly chart below shows that the pair has been overbought and is within striking distance of key resistance near the psychological 135.00 handle, a situation that could pave the way for a near-term pullback. If prices are rejected from current levels, initial support appears at 131.35, followed by 128.50. On the flip side, if bulls maintain control of the market and manage to push USD/JPY above 135.00 decisively, the focus shifts upwards to the 1998 high at 147.65.

USD/JPY Monthly Chart

USD/JPY Daily Chart

USD/JPY charts prepared using TradingView