USD/JPY Cautious after Monday’s Nearly 24-Year Highs

USD/JPY Analysis

Friday's new rise in US Consumer Price Index for May, to the highest levels since December 1981, crushed hopes for a peak in inflation from recent signs of easing. It also caused a hawkish repricing in market rate hike bets, with CME's FedWatch Tool now projecting a more aggressive 75 basis points increase for this week's meeting and in July, with 90.1% and 76.1 probabilities respectively, at the time of writing. ^[1]

Right before he usual communication blackout period started, we saw a series of high-profile policy maker (and voters), asserting their willingness to keep tightening past September and reaffirming their resolve to bring inflation down.

The central bank has pointed to 50 basis point increases for June and July, as showed by the accounts of the last policy meeting and the relevant press conference by Chair Powell, who had also shut the door to larger 75 basis point adjustments, saying that this is "not something the Committee is actively considering".^[2]

Given this well-telegraphed tightening path, it may be hard for the Fed to break away from it in this meeting, but Friday's CPI print and the repricing by markets, definitely put pressure on officials to take more aggressive action.

The Bank of Japan (BoJ) on the other is being isolated as the only major central bank to stick to its monetary stimulus, since even the European Central Bank (ECB) announced a rate hike path and an end to its asset purchases last week.

The BoJ hands down its policy decision on Friday, but officials have not shown any willingness to reconsider their ultra-dovish strategy, despite the fact that the country's Consumer Price Index excluding fresh food had surged past the banks 2% inflation target in April. Moreover, the Japanese central bank stepped in to the bond market again today and expects to do so again tomorrow - activity that weigh on the Yen.

This has sent USD/JPY to a massive rally this year and gains in excess of 4% during the current month. On Monday, it clinched nearly 24 year highs, piercing 135.00 for the first time since late-1998. Thiss bring 136.92 in the spotlight, but a pullback will likely be required for moving to this level and beyond.

Despite the stark and reaffirmed policy differential between the two central banks and the new high in USD/JPY, it has been consolidating over the last few days, while the Relative Strength (RSI) index has been diverging lower. Today it faces difficulties and a correction towards mid-131.00s would not surprise us, but further decline that would breach the EMA200 (at around 129.70) looks like a tall order.

The repricing in market expectations around the Fed's rate hike cycle sets a potential tricky backdrop for the pair. In any case, the trajectory will likely be determined by this week's policy updates from the Fed and the BoJ, which can spark volatility.