USD/JPY biased lower unless US unemployment reverses its upward trend

• USD/JPY continues to be driven by US rates outlook
• Traders favour follow-up 50 basis point cut from Fed in November
• US labour market indictors to drive rates pricing and USD/JPY moves this week
• USD/JPY biased lower in absence of decline in US unemployment

Overview

The USD/JPY outlook changed materially last Friday with a new Japanese Prime Minister and soft US core PCE inflation report sending it careening through multiple supports as Fed rate cut bets swelled. With a raft of fresh US labour market indicators to digest this week, headlined by the payrolls report on Friday, it may take an unlikely decline in the US unemployment rate to prevent further downside ahead.

USD/JPY market drivers

Looking the correlation analysis below, it’s noticeable the strong, positive relationship between USD/JPY with the US interest rate outlook and yield spreads has weakened slightly over the past month. Rather than being a structural change, my sense is it reflects the impact of short-term factors such as quarter-end capital flows and uncertainty over Japan’s political leadership.

With only one day left in the quarter and the latter now resolved, it’s likely expectations for the scale and pace of Federal Reserve rate cuts may reassert its dominance this week. If correct, traders need to focus on events that can materially shift market pricing. With the Fed fixated on the labour market, incoming data will play a key role in determining whether it will follow up September’s supersized 50 basis point cut with another in early November.

Markets pricing supersized Fed cuts

As of Friday, Fed funds futures were pricing 84.5 basis points of rate cuts over the remaining two FOMC meetings in 2024, implying at least one of those will see a 50 with a decent probability of a second. Looking out to the end of 2025, markets are looking for a further 226.5 basis points of easing, taking the funds rate marginally into loose territory based on the Fed’s latest forecasts.

One thing that has stood out recently is the willingness of traders to pile into dovish rate cut bets when given the opportunity, with curtailment of easing expectations only brief and limited in nature. There was a large market reaction to the details in the Conference Board’s US consumer confidence report last week but only limited interest in data showing labour market conditions and activity levels remain resilient, such as weekly jobless claims. That tells you where the path of least resistance likely lies when it comes not only US rate cut expectations but also USD/JPY.

Managing event risk

Looking at the events calendar, the only release next week that could materially change the prevailing dovish mindset is Friday’s non-farm payrolls report, especially the unemployment rate which is expected to remain at 4.2%. Even though markets still react initially to the payrolls figure despite well documented concerns about the signal it provides, it’s the unemployment rate the Fed is graded on when it comes to its full employment mandate. That makes it and other measures of labour market slack such as the underutilisation and participation rates arguably far more important for the rates outlook and USD/JPY.

Source: Refinitiv (All times US EDT)

Given the prevailing mindset, at a minimum, the unemployment rate would need to hold steady to prevent another shift towards multiple supersized rate cuts. Realistically, it would likely require the rate to decline to pare expectations for a 50 in November. Any increase in unemployment and a 50 may be deemed a lock.

Before the payrolls report, other releases that could materially influence the US rates outlook and USD/JPY include the ISM manufacturing and services PMIs, JOLTS job openings, the ADP National Employment report which has been a decent guide to payrolls growth recently, along with weekly jobless claims.

It’s also a busy week for Fed speakers, but with the key piece of economic data not arriving until Friday, the impact may be muted unless they lay out conditions that could shift expectations for the rates outlook.

Given how tight polls are in the US Presidential election race, the October 1 vice Presidential debate could also generate volatility if there’s an obvious winner.

While it’s a busy calendar in Japan, none of the data points screen as materially important for USD/JPY directional risks, although the minutes of the BOJ’s September monetary policy meeting carry the potential to generate short-term market volatility.

Source: Refinitiv (All times US EDT)

USD/JPY technical picture darkens

The technical picture for USD/JPY shifted meaningfully on Friday with the bearish daily candle not only completing an evening star pattern but also sending the price crashing through not one but two diagonal supports. While not yet confirmed by MACD, with RSI (14) breaking its uptrend convincingly, directional risks for momentum and price are now skewed to the downside.

The September 20 low of 141.75 is the first downside level of note, with 139.60 the next after that. If the latter were to give way, 138 and 135.38 would be the next targets for bears.

On the topside, resistance may be encountered around 143.20, where the August 16 downtrend is located. Above that, the 50-day moving average is an important level, repelling a bullish advance last Friday with conviction.

-- Written by David Scutt

Follow David on Twitter @scutty