Yesterday's FOMC minutes revealed a hawkish stance of the regulator, providing the US dollar with a new driver. However, the greenback initially showed a rather modest upward momentum when trading against the yen and later began to decline. What caused this downturn and what are the prospects for the USD/JPY major?
Wings for USDAt the end of yesterday's trading session, the US dollar index strengthened against a basket of major currencies by 0.26%. The catalyst for the US currency was a more hawkish tone of the Fed's June meeting minutes.
Last month, the US central bank refrained from raising interest rates for the first time since March 2022 when it started its fight against inflation.
Federal Reserve Chairman Jerome Powell repeatedly emphasized that the decision to pause the tightening cycle was unanimous. However, the released minutes showed a different picture.
Although the majority of FOMC members deemed it appropriate to maintain rates within their previous range, some of their colleagues expressed support for a quarter-point increase at the June meeting.
"It is quite obvious that this time the opinions of Federal Reserve officials diverged. Not everyone supported the pause, citing persistently high inflation. This reinforced the theory that in July, the regulator is likely to resume its aggressive policy," noted Lindsey Piegza, Chief Economist at Stifel Bank.
Following the publication of the minutes, the probability of a 25-basis-point interest rate hike this month rose to 89%. For comparison, immediately after the June FOMC meeting, it was estimated at only 62%.
The strengthening of hawkish market expectations regarding the Fed's future monetary strategy led to a rise in US bond yields across the yield curve, providing support to the USD/JPY pair.
Yesterday, the pair jumped by 0.1% to the level of 144.60. However, this morning, it completely erased previous gains and entered a free fall. At the time of writing, the dollar weakened against the yen by 0.6% and was trading at the level of 143.7.
Some analysts attribute the sharp retreat of the USD/JPY pair to increased concerns among traders about possible intervention in the market by Japanese authorities.
Since last week, Tokyo has noticeably intensified its threats against currency speculators who have recently been actively building short positions on JPY due to the dovish policies of the Bank of Japan.
It is worth noting that at its last meeting on monetary policy held in mid-June, the BOJ remained committed to its ultra-loose monetary tactics, which implies ultra-low interest rates and maintaining yields around 0% through the YCC mechanism.
Later, several Japanese officials voiced the regulator's intention to maintain the current strategy in the coming months, which exerted strong pressure on the yen.
Last week, the JPY rate dropped against its American counterpart to a new multi-month low of 145.07. The proximity of the USD/JPY pair to levels at which the Japanese government conducted currency interventions to support its national currency in 2022 prompted Tokyo to once again consider intervention.
However, many experts believe that at this stage, when the Fed is nearing the end of its tightening cycle, Japan is unlikely to initiate large-scale yen purchases as it did last year. And most market participants understand this very well.
That is why the fear of intervention currently does not pose a significant threat to the USD/JPY pair. Although it can limit its ascent, it is unlikely to cause such strong downward volatility as it did this morning.
So what are investors really afraid of? The main risk for the USD/JPY major is significant fundamental changes, particularly a potential hawkish turn of the Bank of Japan.
Speculation on this topic flared up in the market with renewed vigor yesterday. The trigger for this was news from Japan's largest labor union center, Rengo.
The organization reported that wage growth in the country could reach 3.58% in 2023. This would be the largest increase in 30 years.
Wage growth is one of the key indicators closely monitored by the Bank of Japan to determine its future monetary policy.
BOJ Governor Kazuo Ueda has repeatedly emphasized the need to maintain an adaptive policy until wages increase enough to make inflation stable.
"The increase in wages in Japan can indeed stabilize inflation at around 2%, which will eventually prompt the central bank to normalize its policy," said Hisashi Yamada, an economist at Hosei University.
At this stage, market participants do not expect a sharp monetary turn in the near future. However, they are actively betting that the regulator may take its first step in a hawkish direction in July by adjusting its yield curve control policy.
It is possible that closer to the July BOJ meeting, market expectations regarding YCC changes will intensify. This could exert significant pressure on the USD/JPY pair.
Near-term outlook for USD/JPY
This week, the key trigger for the USD/JPY pair will be tomorrow's report from the US Department of Labor on nonfarm employment for June. Currently, the American economy is expected to have added 225,000 jobs last month. The unemployment rate is projected to decrease from 3.7% to 3.6%.
If we receive evidence that the US labor market remains strong despite the prolonged tightening of monetary conditions in the country, it will strengthen hawkish sentiment among traders regarding the Fed's future actions.
In such a case, the dollar may once again demonstrate a strong surge across the board. However, its trajectory against the yen is likely to be limited due to concerns about intervention and speculation about upcoming policy changes by the Bank of Japan.
Weaker employment data in the US, on the other hand, could be a cold shower for dollar bulls. If traders see a significant slowdown in the US labor market, it could weaken their expectations for two additional rate hikes this year.
In such a scenario, the dollar will face a full-scale sell-off, but it is most at risk of falling against the Japanese currency, as USD/JPY appears to be heavily overbought.
The MACD indicator, which shows shrinking green bars, also suggests a possible continuation of the decline.
Important levels to watch at the moment are support levels at 144.00, 143.70, and 143.30, as well as resistance levels at 144.90, 145.00, and 145.07.
According to UOB economist Sue Ann Lee, the dollar buyers will strive to maintain the upward momentum in the short term, but at this stage, a break above the key threshold of 145.00 appears highly unlikely.