USD/JPY forecast: Fed rates outlook resumes control, eyes on payrolls, ISM services

• US economic data likely to drive USD/JPY moves this week
• Fed in media blackout ahead of June FOMC meeting
• Nonfarm payrolls, ISM services could shift US rates outlook
• USD/JPY long-term risks remain skewed to downside

Directional risks for USD/JPY look set to be driven by economic data this week, helping to shape opinions on the US interest rate outlook given an absence of Fed speakers. With a raft of labour market figures to digest, headlined by nonfarm payrolls, along with an important read on the key US services sector, the environment looked primed for increased volatility in USD/JPY.

Fed rates outlook driving USD/JPY

After weakening at the turn of the Japanese fiscal year and intervention episode in the Japanese yen from the Bank of Japan in late April, correlation analysis suggests expectations regarding the Federal Reserve’s interest rate outlook are heavily influencing USD/JPY again.

This chart shows the rolling daily correlation of USD/JPY against a variety of different financial variables.

At 0.96, the yen has had an extremely strong relationship with the offshore-traded Chinese yuan in the past month, meaning any significant actions from the People’s Bank of China regarding the yuan are likely to influence the yen.

USD/JPY has also seen a strong relationship with short-end US interest rates, proxied in this instance by the shape of the 2024 Fed funds futures curve. Essentially, how many basis points of rate cuts markets are pricing this year. The correlation sits at 0.86 and has been strengthening.

It’s a similar story for US two-year Treasury yields, sitting with a correlation of 0.77 with USD/JPY. In contrast, the previously tight correlation with yield spreads between benchmark 10-year US and Japanese bonds has broken down, turning mildly negative over the past month at -0.36. That implies no real relationship between the two variables.

Two data releases stand out

In the absence of a big shift in market drivers or a black swan event, the correlations point to Fed rates pricing being in the driver’s seat for USD/JPY. With the Fed media blackout in place ahead of the June FOMC meeting, that means US economic data should be extremely influential this week.

While it’s a busy US calendar there’s only two events that have the potential to meaningfully shift Fed pricing.

The first is the ISM non-manufacturing PMI on Wednesday, providing a real-time read on the health of the key US services sector. The separate S&P Global US composite PMI released two weeks ago stunned traders, accelerating by the most in two years, led by the services sector. It was stronger than even the most optimistic forecaster and generated some big moves in markets. If the ISM survey confirms the S&P report it will suggest the US slowdown in the first quarter was temporary, mirroring the strength seen in the Atlanta Fed’s GDP Nowcast model for economic growth in the June quarter.

Two days later, the May nonfarm payrolls report arrives, providing another event that could shift rates pricing meaningful. While the payroll figure gets most of the media attention, I’d argue that in terms of the Fed and monetary policy outlook, the numbers likely to influence markets are the unemployment rate and average hourly earnings. I wrote a brief note explaining why earlier this year.

While I’d love to tell you the Japanese data calendar should be watched closely, my job is to help with your trading, not provide a list of events that will be lucky to move USD/JPY more than a few pips. It’s been a long time since Japanese economic data moved the yen, and looking at the calendar this week, it’s hard to see that changing.

The release that may be of interest is Tuesday’s wages report given we know the BOJ is banking on big increases to help boost consumer demand and inflation. But we know shunto wage negotiations earlier this year delivered the largest increase in over three decades, so the only element of surprise will be if that doesn’t begin to flow through to non-unionised workers. 

Outside the US and Japan, the Bank of Canada and European Central Bank are expected to begin their easing cycles, with the latter a higher probability than the former. Both could generate volatility in markets, especially if they don’t cut or signal a reluctance to deliver follow up moves. The BoC decision arrives Wednesday with the ECB on Thursday.

USD/JPY technical analysis

Aside from the wild price action in late April and early May coinciding with record- braking intervention from the Bank of Japan to support the yen, the thing that stands out on the USD/JPY chart is that, for now, the price just wants to keep grinding higher.

Since May 3, we’ve seen a series of higher lows and higher highs, fitting with the directional signal from the 50 and 200-day moving averages. While not the only factor, that’s not dissimilar to what we’ve seen in Fed rate cut pricing, underlining that what happens on that front may be influential on USD/JPY.

But the sideways price action seen last week suggests upside momentum is stating to wane. You can see it visually on the charts. For mine, that suggests we need to see more data that weakens the case for Fed rate cuts this year to encourage more buyers from the sidelines, otherwise downside risks will soon start to materialise.

Resistance is located at 157.71 and 160.23. Sellers may also be lurking at 158. Support is found at 156.57, 155.55 and 153.62. Also keep an eye on the uptrend highlighted on the chart. Yes, it’s only two points, but on both occasions the price bounced strongly from it. That suggests it may get more attention than what would otherwise be the case.

-- Written by David Scutt

Follow David on Twitter @scutty