USD/JPY collapses to test 114 the figure, 113.99 traded

• USD/JPY has traded at 113.99 on Thursday as the US dollar bleeds out.
• US yields are on the back foot again as markets rethink balance sheet runoff.

USD/JPY is on the verge of breaking below 114 the figure at the time of writing after falling from a high of 114.70 today. The US dollar is being kicked down along with US yields as markets think twice about a faster pace of tapering by the Federal Reserve and wonder if they have priced the Fed too hawkishly. 

Both the Federal Reserve chair, Jerome Powell, and Philly Fed President Patrick Harker, while alarmed by inflation and suggesting that rates could be lifted as soon as March have both said the Fed can be patient with regards to the balance sheet run-off. In other words, they have been less hawkish than some other officials and what the market is pricing for.

Harker said he sees the Fed starting to shrink its balance sheet “in late 2022 or early 2023” after the central bank has raised its target rate sufficiently, to around 1 per cent from near zero. Meanwhile, Powell has said that the central bank could start to shrink its balance sheet later this year. 

''We're going to end our asset purchases in March, meaning we'll be raising rates over the course of the year," Powell said on Tuesday at his confirmation hearing before the Senate Banking Committee.

"At some point, perhaps later this year, we will start to allow the balance sheet to run off, and that's just the road to normalising policy," he said, adding the US economy "no longer needs or wants" the Fed's very highly accommodative policies.

The rhetoric is less hawkish than, say the likes of Atlanta Fed President Raphael Bostic. "There is a risk inflation is likely to be elevated for an extended period of time and we need to respond directly, clearly and aggressively," Bostic told Reuters in an interview on Monday. 

Bostic said the central bank should be aggressive with regards to the balance sheet as well, allowing its holdings to decline by at lease $100 billion a month, and with plans to quickly pull at least $1.5 trillion out of financial markets that he considers pure "excess liquidity."

The mixed messages from the Fed is making for a varied response in the markets at the start of this year. Initially, the US dollar was on the front foot along with US yields. The 10-year yield rallied to 1.8080% but it has since fallen to 1.7110%. Today, the yield is steeply lower again but above yesterday's aforementioned low.  

All eyes on US data ahead of Fed decision

Nevertheless, USD/JPY is on the backfoot and will likely remain so until yields begin to stabilise again. At midnight tomorrow, after Fed's Williams speech, the media blackout goes into effect and we will get no more Fed speakers until Chair Powell’s post-decision press conference on January 26. Therefore, the data will be the driving force. 

Today, the Producer Price Index confirmed that the pipeline price pressures remain high. ''With firm pricing power strong, this will likely lead to pass-through to consumer and should keep the Fed concerned about further CPI acceleration,'' analysts at Brown Brothers Harriman explained. 

Tomorrow, Retail Sales will be important. However, ''Retail Sales probably fell in December, even with higher prices boosting nominal values,'' analysts at TD Securities argued. ''Spending was likely held down by the fading of fiscal stimulus, payback for earlier-than-usual holiday shopping, and Omicron. Real as well as nominal spending was likely still up strongly on a QoQ and a YoY basis.''