USDJPY could rally on growing FedBoJ policy divergence

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By :  ,  Financial Analyst

Much was made of US President Donald Trump’s historic summit with North Korean leader Kim Jong Un but in the end there was no fireworks and it turned out to be a bit of a damp squib. They signed a pact which included a pledge to work towards “complete denuclearisation” on the Korean peninsula. In return, Trump has committed to provide security guarantees to North Korea. However, US sanctions will still remain in place but the US will be “stopping the war games which will save us a tremendous amount of money. It is very provocative.” Trump was referring to the regular US joint military exercises with South Korea.

Muted market reaction at Trump/Kim accord

The stock markets in Asia gained ground as investors re-priced reduced geopolitical risks in the region but there wasn’t much follow-through at the start of the European session.  In the FX markets, the safe haven Japanese yen weakened but only slightly while gold also edged lower as it struggled to move away from that pivotal $1300 handle.

Focus returns to economic fundamentals

The market’s focus will now start to turn to this week’s key fundamental events. As well as three major central bank meetings, there will also be plenty of macroeconomic data to keep traders busy. Today’s publication of US inflation is the last significant piece of US data before the Federal Reserve’s rate decision on Wednesday. Headline CPI is expected to have risen 0.2% in May – the same amount it did in April – with core CPI also seen climbing again by 0.1% month-over-month. On a year-over-year basis, CPI is expected to have risen to 2.7% from 2.5% and core CPI to 2.2% from 2.1% previously. Should the inflation figures match or better still beat expectations then the dollar could extend its gains, especially against currencies where the central bank is likely to remain dovish for the foreseeable future – such as the yen.

Interest rate differential between Japan and US set to grow further

The Bank of Japan is fully expected to maintain its policy unchanged on Friday and re-iterate the need to keep policy extraordinary loose in order for the stubbornly low Japanese inflation to climb towards the bank’s target over time. Meanwhile as far as the Federal Reserve is concerned, well the market fully expects it to raise interest rates on Wednesday for the second time this year. But the key question remains: how many more hikes will there be for the rest of the year? In the FOMC press conference, Fed Chairman Jerome Powell could hint at the prospects of two more hikes in 2018 following the recent improvement in US data. His FOMC colleagues will have updated their projections on interest rate direction and timing in the so-called dot plots. If there is indeed a general tilt towards four increases in 2018 as a whole, this should give the dollar another shot in the arm, as previously the Fed had hinted at three rate increases for the year.

Could USD/JPY break THIS stubborn bear trend this week?

If that’s indeed the case then the USD/JPY could potentially resume its rally from end of March and make another attempt at breaking its long-term bearish trend line in the 110.00-112.00 region. If and when this resistance area is eroded only then will the bias turn decisively bullish. But while it remains below this area, the technical bias remains neutral (“neutral” as opposed to bearish because it may have formed a higher low at 105.00). A couple of short-term support levels to watch are at 109.85 followed by 109.00 with a slightly longer term support coming in at 107.30.

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