USD/JPY steadies above 108.00, set for best week since May 2020

• USD/JPY is off highs but remains comfortably above the 108.00 level.
• The pair is set for its best week since May 2020, having largely traded as a function of US government bond yields.

USD/JPY has backed off from earlier session highs of above the 108.60 mark in recent trade and, as the end of the trading week draws closer, seems content to range around the 108.25 region. Though off highs, USD/JPY seems to be attracting a lot of buying interest ahead of the 108.00 level, which is keeping things supported for now.

On the day, the pair is up 0.3% or just over 30 pips. That means that USD/JPY is on course for its largest weekly gain since May 2020 (of 1.7% or about 180 pips). That means JPY sits at the bottom of this week’s G10 FX performance table, with only CHF (down 2.4% on the week) doing worse.

Driving the day

USD/JPY appears to have traded as a function of US government bond yields, or as a function of US/Japanese rate differentials which tend to move in line with US bond yields given the fact that Japanese government bond yields hardly move given the BoJ’s Yield Curve Control policy (where it target’s 10-year JGB yields at 0.0%). The US 10-year yield spiked as high as 1.625% on Friday, its highest level since early February 2020 (i.e. before the pandemic went global and triggered a financial market panic), in wake of a much stronger than anticipated US Labour Market Report. However, the move did not last long, with yields quickly dropping back to pre-data levels in the mid-1.50s%.

Looking ahead, US/Japan rate differentials look set to remain a key driver of the USD/JPY currency cross. The outlook for US bond yields is pretty bullish; Friday’s jobs data has boosted expectations for a strong post-Covid-19 rebound that were already sky-high given the rapid vaccine rollout, recent easing of Covid-19 restrictions and expectations for further fiscal stimulus. Thus, the outlook for USD/JPY also looks pretty good.

As long as nothing scuppers the US’ path to recovery, which it looks like it won’t  – vaccine-resistant Covid-19 variants have been a concern recently but according to the latest results from AstraZeneca, their vaccine appears to be effective against the Brazilian variant – and as long as the Fed don’t suddenly surprise markets with more QE or dovish adjustments to their existing programme, there is no reason to think that US bond yields can’t continue higher. Indeed, the main driver of higher yields this week (and the main driver of USD/JPY strength) was Fed Chair Jerome Powell’s failure to signal Fed readiness/eagerness to combat rising yields.

There is always the possibility, however, that the only reason why Powell failed to talk about what the Fed could do to stop yields rising or when they might act is that the FOMC has not yet had the chance to come to agreement on this issue. The FOMC meeting in two weeks’ time would offer such an opportunity. A dovish surprise could see bond yields hit and USD/JPY drop. But that is two weeks away and a lot can happen in that time.