The USD/JPY pair reached a new high of 145.00 on Friday, as the US dollar gained strength following the release of higher-than-expected inflation data. The pair has risen by more than 2% this week, reflecting the growing divergence between the monetary policies of the US and Japan.
The main driver of the USD/JPY rally was the US Producer Price Index (PPI) for July, which came in at 2.4% year-on-year, slightly above the market consensus of 2.3%. This was the highest annual increase in PPI since November 2018, indicating that inflationary pressures are building up in the US economy.
The PPI measures the changes in prices received by domestic producers of goods and services. It is considered a leading indicator of consumer inflation, as producers tend to pass on higher costs to consumers. Therefore, a higher PPI could signal that the US Consumer Price Index (CPI), which is due next week, could also surprise to the upside.
A higher inflation rate could prompt the Federal Reserve to tighten its monetary policy sooner than expected, as it has a dual mandate of maintaining price stability and full employment. The Fed has kept its benchmark interest rate near zero and its monthly bond purchases at $120 billion since March 2020, in response to the COVID-19 pandemic. However, as the US economy recovers from the crisis, some Fed officials have expressed their willingness to start tapering the bond purchases later this year.
US Consumer Confidence Improves in August
Another positive factor for the USD/JPY pair was the improvement in US consumer confidence in August, as measured by the University of Michigan’s preliminary Consumer Sentiment Index. The index rose to 81.2 from 80.8 in July, beating the market expectation of 80.5. The index reflects consumers’ assessment of current economic conditions and their expectations for the future.
The report showed that consumers were more optimistic about their personal finances and income prospects, despite the rising inflation and the resurgence of COVID-19 cases due to the Delta variant. The report also noted that consumers expected the Fed to raise interest rates in late 2023 or early 2024, which could support the US dollar in the medium term.
Japanese Yen Weakens on Dovish BOJ Outlook
On the other hand, the Japanese yen weakened against the US dollar, as investors continued to bet on a dovish stance by the Bank of Japan (BOJ). The BOJ has maintained its ultra-loose monetary policy for years, keeping its short-term interest rate at -0.1% and its target for the 10-year government bond yield at around 0%. The BOJ has also expanded its asset purchases and lending programs to support the Japanese economy amid the pandemic.
However, unlike the Fed, the BOJ has shown no signs of changing its policy direction anytime soon, as Japan faces a slower recovery and a lower inflation rate than the US. Japan’s GDP contracted by 1% in the first quarter of 2021, and is expected to grow by only 0.2% in the second quarter, according to a Reuters poll. Japan’s CPI fell by 0.5% year-on-year in June, far below the BOJ’s 2% target.
The widening gap between the US and Japanese bond yields also weighed on the yen, as investors sought higher returns elsewhere. The US 10-year yield rose to 4.18% on Friday, while the Japanese 10-year yield fell to -0.01%. The yield spread between the two countries reached its highest level since November 2018, making the US dollar more attractive relative to the yen.
Technical Analysis: USD/JPY Breaks Above Key Resistance
From a technical perspective, the USD/JPY pair has broken above a key resistance level at 144.91, which was the previous high reached in November 2018. This opens up the possibility of further gains towards the next resistance levels at 145.50 and 146.00.
The pair is trading well above its 20-day, 50-day, 100-day, and 200-day simple moving averages (SMAs), indicating that the bulls are in control of both the short-term and long-term trends. The relative strength index (RSI) is above its midline in positive territory with a northward slope, suggesting that there is still room for more upside momentum. The moving average convergence divergence (MACD) is also displaying green bars, pointing towards a strengthening bullish trend.
On the downside, the immediate support level is at 144.50, followed by 144.10 and 143.75. A break below these levels could signal a correction or a reversal of the uptrend.
