USD/JPY Weekly Outlook: Can the Fed or BOJ finally force a breakout?

• USD/JPY shrugs off lower oil and softer US inflation
• Warsh's first Fed meeting in charge takes centre stage
• BOJ hike priced, QT is the wildcard.
• US-Iran deal negotiations remain fluid
• Bulls retain a slight edge near 160.

The Yen's Perfect Window

USD/JPY failed to break lower last week despite receiving a perfect window to do so. Crude oil prices tumbled on growing optimism that the US and Iran may finally be closing in on a deal, dragging Treasury yields lower as softer energy prices helped reinforce the message from weaker core CPI and PPI readings. Yet the pair could barely unwind, rebounding back above 160 by Friday's close.

If the yen can't rally in that environment, when will it?

Source: TradingView

The correlation matrix above suggests be it energy, risk appetite, yield differentials or the Fed outlook, what's actually driving the pair is confusing. While shifts in Fed pricing have shown the strongest relationship over the past week, curve dynamics can be lumpy, making it dangerous to read too much into it. It's difficult to argue any one factor is currently the dominant driver.

That's what makes this week's event risks so important, with the Federal Reserve rate decision the undeniable headline act.

Dots, Guidance and Warsh

Jerome Powell is gone, leaving Kevin Warsh to oversee his first FOMC meeting as chair. With nothing priced for this meeting in terms of a hike or cut, the forecasts, guidance and what Warsh has to say in his first press conference will be key.

The updated dots may also prove to be among the last in their current form should some of the changes speculated upon recently eventually come to pass. Back in March, the median dot had a cut this year and next, with the longer-run fed funds rate sitting at 3.1%. The question now is whether the updated profile has any cuts priced in for the median dot, or whether it shifts to policy rates remaining unchanged.

My sense is we may still see easing retained in the 2027 and 2028 profiles as it would be difficult to see the median FOMC member suggesting neutral rates are around 3.5-3.75%, where the fed funds rate now resides. 

Source: TradingView

With 31.5 basis points of hikes priced by the middle of next year, at the very least I think the Fed needs to jettison the easing bias to meet market pricing. Back in April, the Committee said: "In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks."

Beth Hammack, Neel Kashkari and Lorie Logan voted against retaining that easing bias, while more members have since said they don't see the need to flag further rate cuts right now, including influential Governor Christopher Waller. That suggests it may binned this meeting. 

If the Fed signals there are no further cuts in the profile, it may act to fuel further dollar strength, especially if it suggests the easing cycle is done. I don't see that happening even if markets do right now.

The Risk of a Dovish Hike

If the Fed fails to deliver a major surprise, the obvious question becomes whether the BOJ can provide it instead.

With markets having all but priced a 25 basis point hike to 1%, the question isn't whether the BOJ goes, but how it communicates what comes next. When having tightened in the past, the BOJ's messaging has often come across as dovish, reflecting concern that normalisation risks creating instability in markets.

Source: Bloomberg

The Nikkei newspaper reported last week that officials may slow or even pause the runoff of the BOJ's bond holdings, known as quantitative tightening. If it pairs the widely anticipated hike with a slowdown or halt in QT and delivers the cautious message seen previously, it risks pressuring the yen despite raising interest rates.

As discussed in separate analysis released last week, if the BOJ is seen to be acting more decisively to artificially cap yields to counter market forces, the release valve for pressure on bonds may come via downside in the yen.

To counter the threat of renewed yen weakness, the BOJ needs to convey a confident message that further normalisation remains the right thing to do should the bank remain on track to meet its forecasts.

Governor Ueda's absence may prove influential on that front. With Ueda not voting due to illness and Deputy Governor Uchida fronting the post-meeting press conference, the vote itself may provide another signal on policymakers' thinking. A unanimous decision to hike, coupled with dissent against slowing or stopping QT, should policymakers decide to go down that path, may represent the optimal outcome for supporting the yen.

Peace Deal or More Headline Hockey?

The other event risk this week is the flagged deal between the US and Iran. Both sides have suggested they're as close as they ever have been to getting an agreement over the line, but we've seen enough false dawns to know a degree of scepticism is warranted. There's speculation the ink could hit the paper before markets open on Monday, but it's an incredibly fluid situation.

Even if a deal is signed, last week's price action suggested the threshold for generating sustained downside in USD/JPY may be far higher than many assume.

It leaves me thinking that, unless we get a highly unlikely outrageous hawkish surprise from the BOJ or dovish surprise from the Fed, only a major risk-off event capable of generating significant pressure on carry trades is likely to spark serious downside. But even that looks difficult to envisage in the current environment. Risk appetite remains buoyant, while Japanese yields remain low, stable and well below those available elsewhere in the developed world.

While it's difficult to see significant upside for USD/JPY given how many positives the US dollar side of the equation already have going for them right now, it's equally hard to see meaningful downside emerging until we have concrete evidence that US economic activity is rolling over. It's a stalemate, with a sideways bias marginally tilted higher for the moment.

The BOJ can intervene again on behalf of the Ministry of Finance, slowing the grinding move higher. But as seen in late April and early May, even deploying tens of billions to prop up the yen doesn't last long in this environment.

Data Risks Take a Back Seat

Source: TradingView (US EDT)

Outside the Fed, BOJ and potential deal, the economic data calendar is unlikely to be influential. US retail sales would likely require a significant undershoot to challenge the hawkish Fed pricing currently in place, while the importance of Japan's national CPI print continues to dwindle given Tokyo inflation arrives around three weeks earlier and often provides a good steer on the nationwide outcome.

Intervention Territory

Source: TradingView

USD/JPY continues to grind higher within an established uptrend dating back to the middle of May, continuing to attract dip buyers when the pair pulls back towards it. While a bearish breakout was attempted last Thursday, the price was quickly rammed back higher, ultimately seeing the pair push back above 160 on Friday.

For now, the uptrend is the immediate downside level to watch, with Thursday's low of 159.55 and the 50-day moving average just beneath 159 others that should be on the radar. Overhead, the pair stalled last week at 160.60, just shy of the 160.73 high set in late April before the BOJ and its intervention bazooka waded back in. The latter is the level to keep an eye on this week. If surpassed, the longer the price remains above the former highs, the more it may embolden bulls to test the Ministry of Finance's patience looking for a retest of 161.95.

It's only a hunch, but disorderly moves post the BOJ meeting that generate yen weakness may prompt another intervention episode, even if it comes before the Fed. The other obvious window is Friday when markets thin down for the Juneteenth holiday in the US.

From a momentum perspective, RSI (14) sits above 50 while MACD continues to sit in positive territory above the signal line. However, the former has declined recently and the latter looks like it's rolling over, suggesting momentum is waning, providing a cautionary message for bulls. They're still marginally in control, but they don't have it entirely their way.