Yesterday was a black Tuesday for the dollar. A cooler than expected US inflation report sent the greenback into free-fall in all directions. The biggest losses were sustained by USD/JPY.
Just like last month, U.S. inflation gave traders a shocking surprise. The consumer price index increased by only 7.1% from a year ago. That was less than economists' preliminary estimate of 7.3% and the previous value of 7.7%.
The so-called core CPI, excluding volatile food and energy prices, also turned out to be softer. It rose 6% on an annual basis against a forecast of 6.1% and an increase of 6.3% in October.
The significant reduction in inflationary pressures eased the market's hawkish expectations about the Federal Reserve's future monetary policy.
Following this data, the dollar collapsed on all fronts. Yesterday, the DXY index plummeted about 0.9% to 104.02.
The USD/JPY pair showed the worst dynamics, as the yen jumped, boosted by a rally in Treasuries. US bond yields sank with the US 10-year falling from 3.60% to 3.43%.
In this backdrop, the major collapsed by more than 250 points, or 1.5%. Tuesday's low was the lowest of the week at 134.67.
Such a sharp decline in USD/JPY significantly damaged the outlook for the dollar. The price is back under the area of the 200-day Simple Moving Average, which indicates a clear technical advantage of the bears.
A break under 134.60 would expose the next support around 134.10. Below attention would turn to the monthly low at133.60.
According to analysts at Rabobank, by the end of the week, the USD/JPY risks falling even lower, if the bears stay the course. The downtrend may get support from today's Fed monetary policy meeting.
If the Fed's stance turns out to be more dovish, there is a high probability that the USD/JPY pair will test the level of 130.00 even before the weekend. It has not been uncommon for the yen to fly 500 pips in a week, experts said.
Eyes now turn to the Fed meeting with investors particularly interested in the press-conference of Fed Chairman Jerome Powell.
Investors have already fully taken into account the possible slowdown in rate hikes in the U.S. Now most market participants expect that the rate will be raised not by 75 bps, but only by half a percentage point.
If the forecast comes true, it probably won't put much pressure on the dollar. What could really bring down the U.S. currency is the Fed's hint at lower interest rates.
In light of the latest U.S. inflation data, traders have revised their forecast for peak interest rates downward.
At this point, the rate is expected to rise to 4.8% next year, after which the U.S. central bank will wind down its anti-inflation campaign.
The lower end rates also suggest a less drastic tightening. Many traders are now inclined to expect the Fed to raise interest rates by 25 bps in February and March.
Such a scenario is extremely unfavorable for USD/JPY, which rose to 30-year highs this year due to a strong interest rate differential between the Fed and the Bank of Japan.
Now that there is hope for a less aggressive rate of the U.S. central bank, the yen might regain its lost ground.
However, let's not bury the dollar just yet. Its fate is now completely in the hands of Powell. Many analysts believe that Powell will try to convince investors that the current slowdown does not mean a dovish pivot.
Most likely, the Fed chief's main argument for further tightening will be the fact that inflation is still very high. It is now running three times higher than the central bank's target level.
Earlier, Powell repeatedly stressed that officials won't prematurely end their assault against inflation until the consumer price index returns to 2%.
If he succeeds in strengthening the hawkish expectations of the market, the dollar may gain support and consolidate in tandem with the yen in the short term.