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USD/JPY Fundamental Weekly Forecast – Partial Trade Deal Means Risk Still Exists

James Hyerczyk

The Dollar/Yen rose sharply last week with the buying driven by a rise in Treasury yields and increased demand for higher-yielding assets. The catalyst behind the rally was speculation and the actual announcement of a partial trade deal between the United States and China. Treasury yields rose as investors sold their bond hedges. Stocks were up on the hopes that additional trade deals in the future would ease concerns over a possible U.S. recession.

Last week, the USD/JPY settled at 108.427, up 1.516 or +1.42%.

The dollar was also underpinned against the Japanese Yen as the chances of a 25-basis point rate cut at the end of October dipped from 93.5% to 75.4%.

Dollar/Yen Rise Driven by Higher Yields, Demand for Stocks

The USD/JPY rose last week as the spread between U.S. Government bonds and Japanese Government bonds widened, making the U.S. Dollar a more attractive currency than the Japanese Yen. Furthermore, investors sold long positions in Japanese Yen placed as a hedge against a risky global economy.

Rising stock prices also contributed to the Japanese Yen’s weakness as it kicked off the carry trade whereby investors borrow in Japanese Yen then converted the proceeds into U.S. Dollars to invest in U.S. equity markets.

Partial Trade Deal the Catalyst

The Dollar/Yen was relatively flat for about three days last week before speculation over a potential partial trade deal started to drive it higher last Wednesday/early Thursday. The Forex pair accelerated to the upside after President Trump tweeted at the midday on Friday that “Good things are happening at China Trade Talk Meeting.”

Near the end of the trading session, President Trump said China and the U.S. reached the first phase of a substantial trade deal that delays tariff hikes that were set to kick in this week.

Late in the session on Friday, Trump told reporters at the Oval Office that phase one of the trade deal will be written over the next three weeks.

As part of this phase, China will purchase between $40 billion and $50 billion in U.S. agricultural products. Trump also said the deal includes agreements on foreign-exchange issues with China. In exchange, the U.S. agreed to hold off on tariff hikes that were set to take effect Tuesday.

Additionally, Treasury Secretary Steven Mnuchin said both sides struck an “almost complete agreement” on currency and financial services issues. Phase two of the deal will “start almost immediately” after the first one is signed, Trump said.

Weekly Forecast

The announcement of the first phase of a substantial trade deal was obviously bullish for the Dollar/Yen, but since there was so much long speculation ahead of the announcement, most of the good news was probably priced into the Forex pair.

Now traders have two weeks to mull over a potential rate cut by the Fed, and the Bank of Japan, on October 30 and October 31 respectively. Additionally, investors have about 3 weeks to decide the outcome of the second partial trade deal. This carries some risk so I don’t think the USD/JPY is poised to just take off to the upside.

Furthermore, Morgan Stanley says President Donald Trump’s partial trade deal with China is an “uncertain” arrangement at best and there does not appear to be a viable path to reduce existing tariffs at the moment.

As long as the current tariffs remain in place, the global economy can continue to weaken so chasing the USD/JPY higher at current levels on the news is a risky buy in my opinion. Continue to monitor Treasury yields. They are the best indicator. Higher yields will be supportive. Lower yields could encourage Dollar/Yen traders to reduce their long positions.

This article was originally posted on FX Empire