Japanese Yen Surges After the Fed’s Yellen Has Second Thoughts

Witawat (Ed) Wijaranakula, Ph.D.
Fri Mar 17, 2016

The USD/JPY exchange rate is heading back down to retest the February 11 low of 110.98 yen per dollar, after the Federal Reserve said after the two-day FOMC policy meeting on Wednesday, that it will keep the key interest rate unchanged at between 0.25% and 0.5%, and they may make only two rate increases by the end of the year, half the number that was forecasted at its December meeting. The Fed also trimmed its economic growth outlook for the year to 2.2%, from the previous forecast of 2.4% growth, and its forecast for inflation to 1.2% from 1.6%. 

Fed Chair Janet Yellen sounded more dovish this time, compared to the December FOMC meeting press conference when she said, “Caution is appropriate,”. “Since the turn of the year, concerns about global economic prospects have led to increased market volatility and tighter financial conditions in the United States,”, added Yellen.

The bond market seems to be skeptical, as the yield of the U.S. 10-Year Treasury Note moved 1.52% lower to 1.94% at the close on Wednesday. The yield spread between the U.S. 10-Year and 2-Year Treasury Notes jumped 8.08% to 1.07 percentage points. The yield spread dipped to 0.95 percentage point on March 8, the lowest level seen since late 2007, on concerns about the global economy and aggressive Fed rate hikes. The U.S. dollar index (DXY), a weighted index of the value of the U.S. dollar relative to a basket of six major currencies, fell 0.77% to 95.93, while the USD/JPY dropped 0.55% to 112.55 yen per dollar at the close on Wednesday.

There are warning signs that something is wrong with the U.S. economy, particularly the service sector which accounts for nearly 80% of the private sector gross domestic product (GDP). A preliminary reading of the Markit Economics monthly flash services purchasing manager's index (PMI) for February released last month, came in at 49.8, missing the estimate of 53.5 by a wide margin. A reading below 50 means the service sector of the U.S. economy is in contraction. 

The Institute for Supply Management (ISM) said earlier this month that its index of non-manufacturing activity fell to 53.4 in February, from 53.5 the previous month. The figure was barely above expectations of 53.2 from a Reuters poll of 81 economists. The ISM index has been on its downtrend since October 2015, when the reading was 59.1.

Earlier on Tuesday, the Commerce Department said that U.S. retail sales fell 0.1% month-over-month in February, less than the expected 0.2% decline, but January's sales were revised sharply downward from a 0.2% increase to a 0.4% drop. Following the release of the data, both Barclays and the Federal Reserve Bank of Atlanta cut their U.S. first-quarter GDP forecasts to 1.9%, from 2.4% and 2.3%, respectively.

The dollar was under selling pressure after the Bank of Japan said on Tuesday that it kept its key interest rate unchanged, and from last Thursday’s comments by European Central Bank (ECB) President Mario Draghi after the ECB monetary policy meeting. At the press conference, Mr. Draghi said the central bank didn't anticipate that it would be necessary to reduce rates further after raising monthly asset buys to 80 billion euros, from 60 billion euros, and cutting its main refinancing rate to zero from 0.05%. 

As of March 8, there were 49,600 short positions of Japanese yen, traded on the Chicago Mercantile Exchange (CME) in units of 12,500,000 Japanese yen, by leveraged funds, a decrease of 7,296 contracts since February 9, according to the Commitment of Traders (COT) data released by the Commodity Futures Trading Commission (CFTC). This is compared to about 84,529 long positions, an increase of 22,188 contracts during the same period. 

The CFTC data suggests that the hedge funds have been increasing their long positions and cutting back on their short positions of Japanese yen, resulting in an increase in the net long positions by 29,484 contracts, worth about 368 billion yen. 

From our technical viewpoint, the USD/JPY has been bumping into 113.98 yen per dollar, or the 23.6% Fibonacci retracement level, since mid-February and was unable to break out to the upside. The currency pair resumed it downtrend, as concerns about the weakening global economies continue to put buying pressures on the Japanese yen as a safe-haven currency. Hence, it is likely that the USD/JPY will retest the 110.98 yen per dollar level. The near-term major technical support is at the 106.63 yen per dollar level, or 38.3 Fibonacci retracement, if the Japanese yen continues to strengthen.

According to Bloomberg, Goldman Sachs is unconvinced that yen strength will be sustained, as its chief currency strategist Robin Brooks wrote in a note to clients in February that the bank sees the yen weakening to 120 yen per dollar “in the near term” and 130 yen per dollar by year-end. The median of more than 50 estimates compiled by Bloomberg calls for the yen to slump to 120 yen per dollar by the end of March, and to 123 yen per dollar by year-end.


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