The U.S. dollar is trading higher against all of the major currencies this morning despite stronger Chinese data. The only economic report released today was the University of Michigan’s consumer confidence index, which dropped from 72.9 to 71.3 in the month of January. The decline in confidence was a surprise for some but given the marginal increase in IBD index and the lofty expectations of economists, the big miss was not unexpected. Nonetheless sentiment is at its lowest level since December 2011 and if it remains there, it is not going to sit well with Federal Reserve officials. This week’s U.S. economic reports were mixed. While inflationary pressures remained contained, retail sales rose slightly more than expected in December, housing starts spiked higher and jobless claims fell sharply, the main area of concern is the manufacturing sector, which is losing momentum. Yet for the FX market, this week’s U.S. economic data poses no significant risk to existing trends.

Meanwhile the big focus continues to be on USD/JPY and whether its test of 90 is an initial probe before a stronger break or a failed attempt to clear a key level. Based on more recent comments from Japanese officials, Japan could be more comfortable with the current level of the Yen than they had let on at the beginning of the week. Overnight, Prime Minister Abe’s Economics Advisor Hamada said USD/JPY at 100 was a “good level for Japan.”

From a fundamental perspective, USD/JPY should continue to rise. The Bank of Japan is widely expected to adopt a higher inflation target next week and will make this announcement on Monday evening NY time (Tuesday morning in Japan). While we don’t know whether the central bank will provide a convincing plan to achieve that goal, either tonight or on the Friday and Monday before the BoJ meeting, we expect USD/JPY to stage a stronger break above 90, setting new 2.5 year highs in process. While a 2% inflation target may be ambitious if Japan manages to successfully boost core consumer prices up to 0.5% from its current level of -0.5% it would equate to an approximate USD/JPY value of 95.

From a technical perspective, 90 is a very important level but the key resistance is between 94.50 and 95. When the currency pair broke above 87.50, the 23.6% Fibonacci retracement of the 2007 to 2011 sell-off and a level that coincided with the 2008 low, it officially broke its downtrend and initiated what should become a stronger move higher in USD/JPY.

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