FX.co ★ USD/JPY displays strong volatility

The USD/JPY pair has been extremely volatile throughout the week, swaying violently back and forth. Let's break down the underlying factors of such strong volatility and discuss potential future trajectories of this major currency pair.

What is driving the US dollar?

For the USD/JPY pair, the key driver remains the stark contrast in monetary policies of the US Federal Reserve (Fed) and the Bank of Japan (BOJ).

Notably, the BOJ is currently the only major central bank globally that maintains negative interest rates at -0.1%.

Japanese officials consistently emphasize the need for large-scale monetary incentives until wages and inflation in the country show substantial growth.

On the other hand, the Fed is actively fighting persistent inflation by tightening monetary conditions. Last month, the US central bank raised interest rates by 0.25% to a range of 5.0%-5.25%.

Given that the US economy has remained resilient amidst aggressive policy and continues to perform robustly, the majority of traders anticipate the Fed to maintain its hawkish stance for an extended period.

At present, futures markets predict a pause in the tightening cycle for September, just as it happened in June. However, some investors believe the Fed might resume rate hikes in November, with the odds being estimated at roughly 40%.

So, the plan regarding the Fed's rate seems rather uncertain at the moment. The only consensus amongst market participants is that the Fed won't turn dovish anytime soon.

Most traders are convinced that interest rates in the US will remain elevated not just for this year but at least into the first half of 2024.

This hawkish market sentiment bolsters the US dollar. In August, the US dollar index increased by 1.6%, seemingly on track to conclude its two-month downtrend.

Analysts predict that the greenback might receive another growth boost this week and potentially initiate a new rally if investors get reassurances that the Fed has no near-future plans of easing its policy.

All eyes are currently on the upcoming Friday speech of the US central bank's chairman at the annual Fed symposium in Jackson Hole.

If Jerome Powell reaffirms the market's hypothesis of the US maintaining high interest rates for an extended period, it will serve as potent fuel for the yields of US Treasuries and the dollar.

Experts forecast a sharp surge in volatility across all dollar majors towards the end of the week. Yet, they note that the USD/JPY dynamics might be more modest compared to other pairs.

What concerns the market?

A significant concern is Tokyo's potential currency intervention.

Last week, the pair surpassed the critical 145 threshold, perceived by many as a red line.

In the past year, to prop up its weakening currency, the Japanese government intervened in the market twice. Both times the interventions occurred when the USD/JPY solidified above the psychologically significant level of 145.

This year, while the yen repeatedly dipped against the dollar to this critical threshold, Tokyo has mostly been issuing warnings about potential market interventions.

This behavior has led many analysts to believe that the intervention threshold may have shifted closer to the mark of 150. This view was confirmed by former BOJ official Atsushi Takeuchi. He noted that Tokyo might refrain from intervening unless USD/JPY firmly establishes itself above 150.

Will investors risk antagonizing Japanese authorities with sharp yen fluctuations? Many remember past remarks by the Japanese government that the deciding factor for intervention isn't necessarily how low JPY falls but rather the pace at which it drops.

As a result, caution is the prevailing sentiment among those who trade USD/JPY.

Even if the market conditions turn optimal post Powell's Jackson Hole address, the pair is unlikely to witness a parabolic rise. As Helen Given, a leading analyst, commented, "I still see high potential for interventions. Hence, my forecast for USD/JPY remains at 147. I think this is the highest limit in the current environment."

Technical analysis

Despite the overbought RSI and a MACD signaling diminishing bullish momentum, the formation of a downtrend seems unlikely.

According to experts from UOB, only a break below the 144.50 level would suggest the US dollar is not advancing.

Presently, the bullish predominance is evident as the pair trades above the 20, 100, and 200-day SMA.

If the short-term upward momentum strengthens, the dollar might surpass last week's high around 146.55. However, it is unlikely to have enough momentum to approach the major resistance at 147.50.