The Yen reached an eight month high against the dollar before sharply reversing after hitting trend line support. Technical levels have started to increase in importance as the USD/JPY has started to lose its correlation to fundamental factors. Indeed, risk sentiment has seen its influence over the pair decrease to 40% from 48% a week ago.

USD/JPY

The Yen reached an eight month high against the dollar before sharply reversing after hitting trend line support. Technical levels have started to increase in importance as the USD/JPY has started to lose its correlation to fundamental factors. Indeed, risk sentiment has seen its influence over the pair decrease to 40% from 48% a week ago. The past week has also saw expectations for a rate hike from the Fed decline which has lessened its impact on price direction. Additionally, the Japanese Finance Minister reversal on his strong Yen talk has raised the prospect of intervention and limited the risks that the new political regime will pressure the BoJ into a strong Yen policy.

BoJ Interest Rate Expectations

BoJ interest rate expectations remained subdued despite strong Yen talk from the new Democratic Party and Finance Minister at the beginning of their new regime. Recently, we have seen both ease on their stance with Minister Hirohisa Fujii issuing warnings against excessive Yen strength and the potential of intervention if there are abnormal movements. That led to Overnight Index Swaps dropping to zero before returning to 6.0 today. The threat of intervention could weigh on the Yen and lead to a reversal of recent gains but interest rate expectations should continue to have minimal impact in direction. The upcoming Tankan manufacturing survey for the third quarter deserves watching as it could influence the central bank's outlook for growth and inflation. An improvement to -33 from -48 is expected which would add to the signs that the recession is ending for the island nation. However, it still remains well below the -3 reading from a year ago which will most likely keep the central bank on hold.

FOMC Interest Rate Expectations

Fed funds futures are currently pricing in a 4.7% chance of a rate hike by the end of the year which is slightly higher from a month ago. Interest rate expectations have started to rise after they reached as low as zero following the FOMC's rate decision. Nevertheless, policy makers will most likely refrain from raising rates until the economy starts to see job growth. Therefore, this week's U.S. employment data will go a long way toward influencing future policy decisions and their impact of the USD/JPY's price action.

Risk

An unexpected drop in consumer sentiment to 53.1 from 54.5 in August took the steam out of bull's sails as it offset improving housing data. The main concern over the potential recovery has been whether consumer consumption will pick up the slack when government spending declines. The labor market has remained weak which may be starting to impact sentiment, and if see a jobless recovery then downside risks to growth could increase. This could lead to equity markets giving back some of their recent gains. Although, risk sentiment has seen its influence dissipate over the pair, it has a strong historical track record and should always be watched for clues on future direction.

To discuss this report or be added to the email list contact John Rivera, Currency Analyst: jrivera@fxcm.com