USD/JPY has been in a very strong uptrend over the past 2 months and there are no signs that the rally is abating. Overnight, the currency pair climbed to a yet another fresh 2.5 year high of 91.25 and from its September lows it is up more than 17%. There has been virtually no meaningful retracements in USD/JPY during this extensive rally and with this morning’s solid U.S. durable goods report, the currency pair could be poised for further gains. Durable goods rose 4.6% in the month of December, up from 0.8% the previous month. While this wasn’t a milestone for durables, which can to be volatile, excluding orders for transportation equipment, durables still increased 1.4%. This leads investors to wonder if stronger U.S. data will send USD/JPY to the stratosphere. USD/JPY will eventually reach a level of exhaustion, but the question is the point at which this will occur.

Slope of USD/JPY Rally Should Begin to Flatten

Based upon comments from Japanese officials, we know that the government has no problems with USD/JPY rising to 100, but just because policymakers can tolerate USD/JPY at that level doesn’t mean that it will get there. A move to 100 would involve an additional 9% rally and for that to occur there needs to be a further catalyst. The Bank of Japan’s monetary policy meeting is now behind us and while the central bank shifted to a 2% inflation target, open-ended asset purchases won’t begin until next year. Since Japan is left with the same level of stimulus between now and then, the steps that the BoJ have taken should no longer fuel additional gains in currency pair. This is not to say that the USD/JPY rally is over because the BoJ still plans to be one of the most aggressive central banks over the next 2 years, but the slope of the rally should begin to flatten.

From a technical perspective, USD/JPY’s break above 90 favors a move to the next resistance level of 95, where the 2010 highs lie (see chart below). From a fundamental perspective, in order for USD/JPY to maintain its momentum, the Federal Reserve needs to grow less dovish or the Bank of Japan needs to revisit its 2013 monetary policy.

For USD/JPY to Hit 100, Fed Needs to Grow More Serious About Phasing Out Asset Purchases

While we are not looking for the U.S. central bank to abandon its easier monetary policy this week, there is a new cast of FOMC voters and their views could affect the language in the monetary policy statement. Since the last Fed meeting, U.S. stocks climbed to fresh 5 year highs and U.S. data has been consistently improving. If this trend continues, the central bank could become more serious about phasing out asset purchases this year. The chart at the end of this article shows the correlation between USD/JPY and U.S. 10 year bond yields. If U.S. yields continue to rise on the back of stronger U.S. data or less dovish monetary policy, it would provide a valid catalyst for USD/JPY to reach 95 and maybe even 100. Of course, don’t expect this move to come quickly. This week’s FOMC meeting should have a limited impact on USD/JPY because any discussion of phasing asset purchases won’t be evident until the minutes from the meeting are released a few weeks later, but if the U.S. recovery remains on track, the Fed could start to wind down its programs this year. Part of the decision hinges on the labor market, which is why we’ll be watching Friday’s non-farm payrolls report closely. Another strong month of job growth would keep USD/JPY supported while weaker job growth could be a setback for the currency. Fourth quarter GDP numbers will also be released but the data is backwards looking and will most likely take a backseat to the FOMC rate decision later that day.

Or the Bank of Japan Needs to Revisit its 2013 Monetary Policy

There’s still scope for easier monetary policy from the Bank of Japan this year, which would be just the catalyst that USD/JPY needs for another leg higher. If there are very little improvements in Japanese data over the next few months, the new central bank governor could choose to kick off his term with a fresh dose of stimulus. The sell-off in the Japanese Yen is suppose to provide a tremendous amount of support for Japanese trade activity but as we have seen in the latest trade numbers, the positive impact has been limited. While trade with the U.S., Europe and most of Asia increased, Japan’s territorial dispute with China has hit the export sector hard and almost completely offset the improvements in trade to other parts of the world during the month of December, when the yen weakened significantly. If Japan fails to reach a resolution with China quickly, the economy could continue to suffer the consequences. At this point, with the BoJ meeting behind us, it all rests on economic data. If there are no major economic improvements, the BoJ could be forced to act again which would put additional pressure on the Japanese Yen.

So while we believe that USD/JPY remains in a long-term uptrend, the slope of the rally should begin to flatten as the market waits for a fresh catalyst in the form of changes to U.S. or Japanese monetary policies.

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