FX.co ★ USD/JPY reverses course as yen overtakes dollar

The US dollar tumbled after the latest CPI data indicated that inflation in the US was lower than expected. USD retreated against all major currencies, with USD/JPY suffering the biggest losses.

Funeral march for USD

Like many other economies around the world, the US has faced record high inflation. However, unlike other central banks, the US regulator immediately began aggressive tightening.

Since March 2022, the Fed has already increased interest rates by 75 basis points five times. By the end of the year, these hikes finally pushed inflation down, with yesterday's CPI data being much lower than expected.

According to the latest report, consumer prices dropped below 8% for the first time in eight months. In October, inflation decreased to 7.7%, its lowest level since March 2021, from 8.2% in the previous month, below the forecasted decrease to 8%.

US core CPI also declined, even though economists expected the index to remain unchanged. In October, core CPI fell to 6.3% compared to September's level of 6.6%.

Lower than expected inflation has led to renewed speculation regarding a possible slowdown of monetary tightening in the US.

As a result, the yield of 10-year US treasury bonds fell to 3.80%, knocking down the US dollar as well. Yesterday, the US dollar index suffered one of its biggest declines this year, tumbling below 108.

The US dollar retreated against all major currencies, particularly the Japanese yen, which was earlier considered to be the worst performing major currency in 2022.

Since January, JPY lost 20% against the dollar due to a large gap between US and Japanese monetary policies.

In October, the Japanese yen slumped to a 32-year low of 152 against the US dollar.

Since then, the Japanese currency has risen by more than 7% and recouped a sizeable part of its losses yesterday.

Following the release of US inflation data, the yen jumped by 3.94% against the dollar in its biggest intraday increase since 1998.

Is a yen downtrend over?

Hopes of the Fed slowing the pace of interest rate hikes are the main driving force of the yen rally. In this situation, the gap between US and Japanese interest rates will be smaller than before.

JPY bulls were also encouraged by the latest statements of Fed policymakers.

Lorie Logan, the president of the Fed Reserve Bank of Dallas, stated that falling inflation is a strong case for slowing down the pace of Fed rate hikes.

Patrick Harker, the president of the FRB of Philadelphia, said that lower inflation could lead to the US regulator adopting a less aggressive stance in the upcoming few months.

Traders revised their outlooks on the Fed funds rate following these dovish statements by policymakers.

The markets are now pricing in a 80% probability of a 50 basis point hike in December, up from 55% last week.

Falling hawkish expectations have led to increased USD selling, which is pushing the yen closer towards reversing its downward trend.

"In terms of direction, it's too early to decisively say yen's weakness has ended, but charts say it's over," Yukio Ishizuki, senior currency strategist at Daiwa Securities said.

Yesterday, USD/JPY tested the key support level just above 140, indicating that USD bears are set to push the pair even lower. The dollar could continue its retreat sooner.

From a fundamental analysis perspective, USD/JPY's prospects are unlikely to be bleak in the near future. Today, US markets are closed due to Veterans' Day, and trading activity is likely to be muted. Next week, the pair could find some support from macroeconomic data.

Japan's Q3 GDP data will be published on Tuesday. The GDP is expected to decrease to 1.1% y/y from 3.5% in the previous quarter.

The massive economic slowdown could lead to stronger dovish rhetoric from the Bank of Japan, allowing the US dollar to recover somewhat.

Some analysts also believe that USD/JPY could increase in the future. In the run-up to the next Fed meeting in December, key labor market data and other CPI report will be released, which could increase hawkish expectations in the market.

Most experts, however, predict that the US dollar is unlikely to continue its massive rally because its bullish potential has already run out.

The unexpected decline of consumer prices and core CPI in October indicates that the US economy has passed the peak of inflation. The Fed has already achieved its main goal of reversing inflation, and now it only needs to lead inflation to the target level with small rate increases.