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  • USD/JPY is consolidating close to multi-month highs in the 110.30s, having exploded above 110.00 earlier in the session.
  • A pickup in US government bond yields was the initial catalyst behind USD strength on Tuesday.

USD/JPY is consolidating close to multi-month highs above in the 110.30s, with the pair having exploded above the 110.00 level in the early part of European trade. As things stand, USD/JPY looks set to close the session with gains of about 0.5% or nearly 60 pips.

Technically speaking, recent price action has been bullish. After breaking above the previous March highs at just under 109.40 last Friday, USD/JPY dropped back to test this level on Monday. This mild retracement back to the old monthly highs just under 109.40 were seen by the bulls as an opportunity to get long ad the pair has been on the front foot ever since, rallying more than 100 pips on Tuesday’s high from Monday’s low point. Longer-term bulls are likely targeting a move towards the February and March 2020 highs at 107.71 and 112.23.

Driving the day

A pickup in US government bond yields was the initial catalyst behind USD strength on Tuesday, with the 10-year yield hitting fresh cycle highs above 1.77% earlier on in the session before pulling back towards 1.70% and real yields also rising. However, with bond yields having pulled back in recent trade, USD has had to look elsewhere for impetus and has received plenty in the form of very strong US data.

The first key US data to be released on the session was CaseShiller house price data for the month of February, which was very strong; US house prices are up 12.0% on the year, boosted amid the low-interest rate environment. High levels of house price inflation is not a concern for Fed policymakers who are intent in their insistence that the US needs more inflation, not less. Nonetheless, strong house prices are positive for the economy through the wealth effect (when people are sat on assets that have gained in value it boosts their consumption).

Meanwhile, and perhaps more importantly, Conference Board Consumer Confidence survey for the month of March was also released on Tuesday; the headline index jumped to 109.7 in March, meaning that consumer confidence has now recovered about half of the losses incurred as a result of the pandemic (prior to the pandemic, headline consumer confidence was consistently in the 120s-130s, but in the months after the pandemic it ranged between the 80s-100s). That was the largest jump in Consumer Confidence since the aftermath of the 08/09 financial crisis and reinforces the narrative that the US economy is on the path to recovery as the vaccine rollout continues and the economy returns to normal – this narrative is likely to continue to support USD.

However, the recent rise in Covid-19 cases in the US is triggering some concerns and ought to serve as a red flag that the US is not out of the woods just yet. If the recent uptick in infections turns into a more substantial rise in cases and states re-impose lockdown then this could dent US growth expectations for 2021. Naturally, this would push back Fed tightening expectations and likely push yields lower – both of these factors would be negative for USD and positive for JPY.

One key factor differentiates the US from the EU in the scenario where the US is hit by a third wave of the virus; real-world data on vaccines shows they are highly effective in 1) reducing transmission and 2) in preventing serious symptoms and hospitalisations. The US has vaccinated pretty much all of its population who are at serious risk of dying if they catch the virus. That means any third wave is likely to mostly infect younger, fitter people, meaning no sharp rise in hospitalisation or indeed deaths. In other words, the tolerance for a rise in cases in the US is likely to be higher as long as infections are concentrated in the younger, less at risk population and (as most expect) the hospitals face no risk of being overwhelmed.

All of the above means that (as long as vaccines work) a third wave should not deal a significant blow to the trajectory of the US recovery, plus any third wave is going to be kneecapped as the Northern Hemisphere heads into Summer anyway. As long as the US economy continues to surge back to pre-pandemic health, the risks for USD and US government bond yields remain tilted to the upside.