USD/JPY outlook: Can the yen strengthen despite dovish BoJ?

• USD/JPY outlook: Core PCE inflation among handful of data releases left for 2023
• Next year could be a big one for Japanese yen
• USD/JPY technical analysis: 145.00 remains pivotal level

The post-BOJ bounce in the USD/JPY has lost some momentum, but the pair is going to remain in focus as we head towards the end of this year and start of next.

The Bank of Japan resisted market pressure and maintained its dovish guidance earlier this week, sending the yen sharply lower. Nevertheless, the language used regarding the economic and inflation outlook suggests a potential interest rate hike in the second quarter could be on the cards.

Even if we don’t hear any more concrete signals from the BoJ in early next year regarding a rate increase, the yen will nonetheless be influenced by US and global bond yields, which continue to remain in a downward trajectory as global inflationary pressures continue to ease.

USD/JPY outlook: Core PCE inflation among handful of data releases left for 2023

The US economic calendar will be winding down ahead of Christmas and New Year holiday. This week, we will have the last important macro releases of the year. Today saw both the CB Consumer Confidence Index and Existing Home sales data come in stronger than expected. We will have final GDP, and jobless claims tomorrow, followed by Friday’s publication of the Fed’s favourite inflation measure: the core PCE price index.

Despite a slightly stronger CPI report last week, the Federal Reserve caused the dollar to sell off and sent stocks and gold sharply higher after signalling a definitive end to its aggressive rate-hiking. The FOMC projected three rate cuts in the coming year. For the first time since March 2021, policymakers did not foresee any additional interest-rate increases in their projections. But US economic data has remained mixed, and if that trend continues markets may have to re-assess their views and push their rate cut expectations deeper into 2024. The Fed’s favourite inflation measure, the Core PCE Price index certainly has the potential to cause that shift. A weaker print would be welcomed by the USD/JPY bears.

USD/JPY outlook: Next year could be a big one for Japanese yen

Heading into the new year, it looks like inflationary pressures worldwide will ease up further, paving the way for the start of a big round of interest rate cuts. The ECB, BoE, and Fed are expected to kick off this process, possibly by the end of Q1, although more likely later in the year due to the not-so-dovish stance held by the first two central banks in December. The Fed has plans for three rate cuts in 2024, but the exact timing and scale will depend on the incoming data.

Looking back at recent months, we noticed the yen getting a good boost from expectations of rate cuts. This hints at the potential for significant gains for the Japanese currency in 2024 as central banks actually start making their policies looser and yields drop even more. Towards the end of the year, when the BoJ is expected to start the normalisation process of its own monetary policy, the yen might be even more in demand.

However, it's important to consider the chance that the yen might not perform as strongly as we think. This risk comes into play if the dollar becomes stronger due to the Fed not cutting interest rates much, thanks to a strong economy. In this scenario, bond yields might not fall as much, supporting the appeal of fixed income and undercutting the upside potential of assets with zero or low yields, like gold and the yen.

USD/JPY technical analysis

Source: TradingView.com

The lower highs in USDJPY remain intact despite its recovery, although the bears will now need to see a new bearish signal before they can get excited again, in light of Tuesday’s rally that sent the pair back above the 200-day average.

The key resistance level is around 145.00, which held after the BoJ-related rally on Tuesday. A closing break above this level would be a short-term bullish development.

The bears will want rates to break below the 200-day average on a daily closing basis in order to look for momentum selling pressure again. Price action around the 200-day average has been very important for the USD/JPY this year as you can see on the chart. Let’s wait and see what indications we will get from price action now that all the central banks are out of the way and markets have had a few days to think over their policy outlooks for 2024.

If the USD/JPY does go below the 200-day average again, then this could ignite fresh selling momentum and lead to a potential drop towards 140.00 next.

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R

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