USD/JPY weekly outlook: Fed, BOJ and the energy wildcard

• Fed hike largely priced, BOJ increase fully priced
• Updated Fed dots will shape the policy outlook
• BOJ guidance must validate the hawkish OIS repricing
• Energy remains tightly linked with longer-dated Treasury yields
• Intervention risk continues to distort USD/JPY’s rates relationship

Central banks dominate, energy may decide

All the headlines this week are going to be centred on the Fed and the BOJ. But unless there’s a shock rates call from either, the decisions themselves don’t screen as significant volatility generators.

Instead, it will come down to signalling. For the Fed, that will come via the updated dot plot and economic projections, rather than Kevin Warsh unless he decides to start providing guidance. For the BOJ, it will be the tone of the statement and Governor Ueda’s press conference, given there will be no updated economic projections at this meeting.

The key swing factor that could override all of that central bank discussion is energy. With a tight link between crude oil movements and US yields, and US yields still having a fairly strong relationship with the US dollar, how energy prices evolve could be equally important, if not more so, in determining how USD/JPY performs in the week ahead.

Warsh faces a credibility test

Of all the known event risk this week, nothing comes close to the Fed interest rate decision.

Kevin Warsh has made it clear in his time as chair that, along with not wanting to give markets the answers to the exam before it occurs, he’s also been a strong advocate for allowing markets to evaluate where the appropriate policy rate should sit. After the string of data we’ve seen recently, including Friday’s CPI report, market pricing for a 25 basis point hike to the funds rate has lifted to around 90%.

Source: TradingView

That creates a scenario where, if the Fed doesn’t hike and effectively ignores what markets are signalling about where the appropriate rate should sit, it risks doing serious damage to its credibility and triggering a disorderly reaction, potentially at the back end of the Treasury curve and in the dollar.

The first area of focus will therefore be whether Warsh can convince the FOMC to deliver the hike, or whether we see some splintering with key members voting against it. Any sign of dissent, particularly from influential members, risks sparking a dovish market reaction, whereas an FOMC that is fully on board with the hike would likely do the opposite.

Source: Federal Reserve

Beyond that, attention will fall on the updated Summary of Economic Projections, especially the dot plot. In June, nine of the 18 FOMC members who submitted forecasts signalled they saw the need for at least one hike this year, with six of those indicating more than one. That was substantially different to what had been conveyed three months earlier, when the committee was still projecting a gradual easing cycle with the funds rate eventually troughing around 3%.

Warsh’s press conference will also matter, particularly if we see dissents or a shock rate call. Assuming the Fed hikes, a large portion of the questioning will likely centre on the updated SEP while trying to tease out information on the policy outlook.

So the main questions will be how many hikes are signalled in the updated projections, whether we see any dissents, and what the Fed says about the inflation outlook.

Source: TradingView

Outside of Wednesday’s FOMC decision, the remainder of the US calendar is largely devoid of significant market-moving events. There will be some interest in the retail sales report following July’s surprise decline, although barring another major shock, it is likely to be swallowed up by the Fed later in the session.

BOJ must validate hawkish repricing

Turning to the BOJ on Friday, unless it delivers a stunning 50 basis point hike, all the mail is that rates are going higher. A 25 basis point increase is fully priced.

As such, the focus will be on whether the BOJ can sustain the hawkish shift in expectations that's taken place over the past month. OIS pricing has moved materially higher across the curve, with almost a second hike by year-end now priced and more than three hikes expected by the middle of next year.

Source: Bloomberg

There are no updated economic projections at this meeting, leaving the statement and Ueda’s press conference as the main vehicles for signalling. That means both will need to ooze hawkishness to validate what's priced in the curve. If they don’t, it may deter some newly inked yen bulls from following through with their conviction.

The vote split on the rates call will also be in focus. Multiple dissenters arguing for a 50 basis point move would come across as hawkish, while multiple members preferring to leave rates unchanged would be deemed dovish, even if the BOJ still delivers the expected hike.

Source: TradingView

Outside of the BOJ decision, the Japanese calendar is largely inconsequential for traders. Inflation data for August is released beforehand, but it has been superseded by the Tokyo figures released three weeks earlier and remains heavily influenced by government subsidies, meaning it is now basically overlooked by markets.

The more relevant inflation read arrives the following week, when the BOJ releases its own measure that strips out the impact of government subsidies and other distortions.

Crude, yields and the dollar

While central bank decisions will dominate the headlines, don’t dismiss the importance of energy in determining how USD/JPY fares this week.

The correlation matrix below shows a strong relationship between energy prices and US Treasury yields, particularly further out the curve. Over the past five sessions, WTI’s correlation with 10 and 30-year yields stands at +0.78 and +0.96 respectively, while diesel shows a similarly strong relationship.

Source: LSEG

Correlation doesn’t mean causation, and some of the relationships may be spurious. We don’t know. But for all the narratives around fiscal concerns, the evidence suggests movements at the back end of the curve have been heavily influenced by what’s been happening with energy.

That matters for the dollar because Treasury yields are also showing strong relationships with the DXY. Those links are strongest across the front end and belly, where energy is also showing meaningful relationships, even if the strongest evidence sits further out.

Source: LSEG

So what happens in energy prices could conceivably influence yields either side of the Fed decision, which in turn may also influence the dollar. For USD/JPY, however, that relationship is competing with a far more idiosyncratic factor that may help explain the price action we saw last week: ongoing intervention risk.

Hidden forces still supporting the yen

We saw US Treasury Secretary Scott Bessent make highly unusual statements, such as declaring that he was now “the house” and effectively daring traders to weaken the yen. Japanese Finance Minister Katayama then confirmed again on Friday that Japan remained in close contact with the United States over currency markets.

Then we saw highly unusual price action following the US inflation report, emblematic of how USD/JPY has disconnected somewhat from shifts in US rates, as we’ve seen previously. Core inflation came in hotter than expected, front-end yields pushed higher and Fed pricing increased, yet USD/JPY tried to rally before falling sharply.

We don’t know whether intervention is still taking place, but the price action suggests there is a hidden force making the pair behave differently to what it has in the past. It’s not simply that the BOJ has become hawkish. That has been known for some time and doesn’t explain what we’re seeing.

USD/JPY downside bias remains intact

Source: TradingView

That strange price action following the US inflation report saw USD/JPY’s attempted rally stall above 154.50, a level the pair has now failed above twice since late last week, making it the immediate focal point overhead.

Underneath, the bottom of the current range sits at 152.90, where the pair bottomed early last week. Beneath that, 152.10 is a swing low from January, before 151 comes into view. That is a far more important level, having acted as both support and resistance on multiple occasions over several years. If we were to see a substantial downside unwind, other levels of note include 149.40 and 146.

Above 154.50, 155.50 repeatedly acted as support over periods this year and may now flip to offering resistance. Beyond that, 156.68 and 158 are other levels of note before the 200-day moving average.

More broadly, the string of lower highs and lower lows, the medium and long-term moving averages flattening out or beginning to roll over, and the price sitting beneath all three continue to favour the downside. RSI (14) sits around 29, while MACD is pushing further into negative territory after already staging a bearish crossover.

As such, the message right now favours selling into strength and downside breaks. A bearish bias is preferred heading into this risk-laden week.