USD/JPY: Falling can't go up

After last Friday's impressive rally, the USD/JPY pair went into a consolidation phase at the beginning of the new trading week. What does this pause mean: has the dollar run out of steam or is it just gathering strength for the next surge?

The U.S. currency has gained almost 3% against its major competitors since early February. This is its first gain for the last 4 months.

Strengthening of hawkish sentiment in the market contributed to the dollar's growth. The fact that U.S. inflation has not yet reached a peak gave hope that the Federal Reserve will continue its aggressive policy.

The latest U.S. macro data even gave support to the dollar bulls, which turned out to be better than forecasts.

Traders saw that the U.S. economy is still firmly on its feet, despite tight monetary conditions in the country.

All of this has convinced the market that the Fed will continue to raise interest rates over the coming months and keep them high for much longer than previously expected.

Investors are now inclined to believe that the central bank will raise rates to about 5.4% in July, although back in early February rates were expected to rise only to 4.9%.

The strongest argument in favor of further monetary tightening was the U.S. Personal Consumption Expenditures Index, published at the end of last week.

The abrupt growth of the index, which is the main inflation benchmark for the U.S. central bank, pushed up the dollar to a 7-week peak of 105.3.

The greenback jumped against the Japanese yen. The USD/JPY rose over 1.3% last Friday to 136.5, the highest in 2 months.

The rapid rise in the pair was driven by increased market fears of further monetary divergence between the US and Japan.

Traders now have no doubts about the hawkish intentions of the U.S. central bank, while prospects for a possible Bank of Japan pivot remain dim.

The yen bulls had high hopes for the new governor of the BOJ, Kazuo Ueda, expecting that his accession to power in April would put an end to the ultra-soft policy. However, his first public speech turned out to be more of a dovish one and disappointed the bulls.

Speaking to parliament on February 24, the candidate for BOJ governor cited the main condition for going hawkish. Like his predecessor Haruhiko Kuroda, Ueda will wait for core inflation to show a major shift.

This comment indicates a continuation of the current monetary course in Japan: the new head will not force things when he is at the helm of the central bank.

Ueda has been clear that he is not in a hurry to change policy. It now seems unlikely that the difference in rates between the Fed and BOJ will begin to narrow in the near term. "This is a headwind for the JPY," said Tomo Kinoshita, currency strategist at Invesco Asset Management Japan.

Yesterday, the greenback's rally was interrupted. The dollar showed a steep peak on almost all fronts.

At the end of yesterday's trading, the DXY index was down 0.6%. Against the yen, however, it was down just 0.2% as investors continued to wager on the risk of further escalation of monetary divergence between the U.S. and Japan.

On Monday, BOJ candidate Ueda said that the merits of the current monetary strategy outweigh its side effects, and stressed the need to maintain an ultra-soft monetary policy to support the fragile Japanese economy.

Due to the general weakness of the greenback, the USD/JPY asset was not able to benefit from Ueda's dovish comments. Nevertheless, it managed to avoid major losses unlike the rest of the dollar majors. The quote is still above the round figure of 136.

Yesterday, the greenback was put under strong pressure by the release of data on the U.S. Durable Goods Orders. In January, the indicator fell more than economists predicted and amounted to only 4.5%. This is less than the previous value: in December, the volume of orders for durable goods increased to 5.1%.

According to analysts, the report slightly weakened the hawkish mood that has dominated the market lately. But for the full clarity of the picture now investors need to get another portion of important US macro data.

This week, the manufacturing and non-manufacturing PMIs will be published.

If the ISM data proves to be positive, the dollar will receive another boost. Otherwise, the greenback risks falling, but its decline will not be strong, experts predict.

"Until the market gets a look at the next non-farm payrolls as well as the next consumer price index, the market is going to be reluctant to push the dollar meaningful lower," analyst Joe Manimbo said. "The market is just realizing the road to 2% inflation is likely to be longer and more winding."

The U.S. unemployment report for February will be released on March 10, and fresh U.S. inflation data will be released on March 14. At this stage, these are the most important triggers for the dollar, which can change its dynamics very abruptly.

If traders see that the labor market remains tight and price growth remains solid, that will likely raise the outlook for the Fed's next move.

Right now, most investors expect U.S. officials to raise rates by 25 bps in March. But there is a view that the Fed will once again return to being more aggressive and raise the rate by half a percentage point.

The strengthening of hawkish sentiment may provide some support to the USD/JPY, which according to experts, in the near future, can again be in the millstone of speculations about the imminent surrender of the BOJ.

Despite Ueda's recent dovish rhetoric, the yen bulls probably won't give up hope for changes, right until Ueda officially takes office and the first meeting.

"Investors continue to bet the BOJ's change of leadership in April will be a catalyst for more policy tweaks," writes Bloomberg. A sign of bullish sentiment for the yen is a sharp rise in the

Citigroup Inc.'s pain gauge, which recently rose above zero for the first time since 2021.

According to the news agency's survey, at this point 70% of economists predict a tightening of BOJ policy by July and 26% expect a hawkish move at Ueda's first meeting in April.

At the same time, some experts warn of the risk that the central bank could adjust its yield curve control program as early as March, before Kuroda will leave his post.

If Kuroda makes such a goodbye gesture, it would certainly support the yen, which is now under pressure from the Fed's hawkish policy. Still, the main topic in the market right now is monetary tightening in the U.S., which is boosting the dollar, said Daisuke Uno, chief strategist at Sumitomo Mitsui Banking Corp.