USD/JPY nudging higher, eyeing 114.50, amid risk appetite, good US data, Japan stimulus news

• USD/JPY is seeing some strength again following Wednesday’s sharp decline.
• After bouncing at 114.00, strong US data, risk appetite and Japan stimulus news supports the case for a higher USD/JPY.

After enjoying its largest one-day (%) decline since August on Wednesday, USD/JPY is trading a little firmer on Thursday. USD/JPY hit its highest levels since early 2017 just shy of the 115.00 level early on during Wednesday’s session, but then sharply reversed to end the session just above 114.00, a 0.64% drop. Having then continued to flirt with the 114.00 level during Thursday’s Asia Pacific trading hours, the pair has since picked up a little. It now trades around 114.40, up 0.3% on the day, with the bulls eyeing a test of the 114.50 level.

The main driver of the drop on Wednesday was a drop in US bond yields; the US 10-year pulled back from a three-week high at 1.65% to under 1.60%. The 10-year is trading flat at the start of the US trading session, thus not offering much impetus for the USD/JPY exchange rate. The reason for the rebound is likely due to dip-buying, which has been a profitable strategy for USD/JPY traders in 2021.

Fundamental developments also seemingly support the case for USD/JPY to continue recovering Wednesday’s lost ground. US economic data released on Thursday was upbeat, with weekly initial jobless claims falling to a fresh post-pandemic low at 269K and the Philadelphia Fed manufacturing survey showing an improvement in business conditions at the start of November.

Meanwhile, reports out of Japan last night showed the Japanese government decided on a much larger than expected JPY 55T fiscal spending package, which would be the largest ever of its kind. Analysts note that fiscal stimulus in Japan tends to boost equities but have a limited impact on Japanese government bond yields, thanks to the BoJ’s yield curve control policy. Analysts say that stronger Japanese equities increases hedging requirements, spurring outflows (and JPY selling).

Elsewhere, risk appetite is solid, with US equities back within striking distance of record levels, undermining demand for the safe-haven yen. More broadly, the main driver of the pair will likely continue to be US/Japan rate differentials. In a note released earlier in the week, Danske Bank said they “continue to expect two rate hikes from the Fed in 2022 (September and December) but also see upside risks to this forecast, with potentially earlier and more rate hikes than we are forecasting for 2022 and 2023”. As a result, think “10Y US Treasury yields set to hit 2% within the next 6-12 months.”