Fundamental Analysis

Yen Pauses After Ending Week on High Note

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USD/JPY has steadied on Monday, following strong losses in the Friday session. In the North American session, the pair is trading quietly at 112.70. On the release front, it's a very quiet start to the day. There are no Japanese events on the schedule. In the US, the sole indicator, the Empire State Manufacturing Index, softened to 9.8 points, much weaker than the forecast of 15.2 points. There are no major US or Japanese events on Tuesday.

It's a light week on the fundamentals front, but we could see some movement from the yen later in the week, as the BoJ meets for a policy meeting. The bank is expected to upgrade its economic growth forecasts in response to the stronger economy. Policymakers have hinted that it will push back its timeline for inflation reaching the 2% target, which currently does not seem a realistic goal, despite years of ultra-loose monetary policy. Will this happen at the July meeting? The markets may not get an answer until the rate statement is released, as the board members are split between those who expect inflation to rise due to the stronger economy, and those who don't think inflation levels will move upwards. If the pessimists prevail, the bank will delay the timing for hitting the 2 percent target from its current forecast of "around fiscal 2018" to a later date. The BoJ has consistently said that it will not reduce its radical stimulus program until inflation levels move closer to the bank's inflation target of 2 percent. However, investors will be looking for any tweaks to current monetary policy, which could trigger some movement from the yen.

The US labor remains close to capacity and the unemployment rate is sparkling, at just 4.4%. So why is inflation mired at low levels? Economists are puzzled, and the Federal Reserve is also at a loss, although Fed Chair Janet Yellen insists that it's only a matter of time before inflation moves higher. In testimony before a Senate committee last week, Yellen insisted that it was "premature to conclude that the underlying inflation trend is falling well short of 2 percent", and that with a strong labor market "the conditions are in place for inflation to move up". However, the markets remain skeptical that the Fed will make a move before the end of the year, with the odds of a December hike at just 43%, according to the CME Group.

Consumer inflation and spending numbers for June were released on Friday, and the data was weak. CPI edged up to 0.0%, short of the forecast of 0.1%. Retail Sales declined 0.2%, missing the estimate of 0.1%. This marked the third decline in the past four months. Consumer spending accounts for 2/3 of US economic activity, so it's no surprise that weak spending has also meant weak inflation, despite Yellen's claim that low inflation is a temporary phenomenon. The US economy had a weak first quarter, with growth of just 1.4%. If the second quarter follows suit, investors could sour on the US dollar in favor of other assets such as the Japanese yen.

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