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02.06.2023 09:16 AM
USD/JPY looking for direction ahead of NFP report

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USD/JPY looking for direction ahead of NFP report

The USD/JPY currency pair continues its downward trajectory, with losses this week already exceeding 1.4%. However, several financial experts remain optimistic about the asset's future. There is a tangible possibility for a return to growth in the short term if today's NonFarm Payrolls (NFP) report takes an unexpected positive turn.

Why did USD/JPY weaken?

On Thursday, the US dollar plunged across the board, including against the Japanese yen. As a result of yesterday's trading, the USD/JPY pair dropped by 0.4% and reached a weekly low of 138.8.

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One of the contributing factors to the major's negative dynamic this week was a warning from Japanese authorities about potential intervention. On Tuesday, the country's government announced that it would take necessary measures if the yen continues to weaken.

Last week, the yen depreciated against the US dollar by more than 1%, reaching its lowest level in six months. This fall was primarily driven by heightened market concerns about an increasing monetary divergence between Japan and the United States.

Just a few days ago, investors were confident that both the Bank of Japan (BOJ) and the Federal Reserve (Fed) would maintain their current policies at the June meetings. The BOJ was expected to maintain super-low rates, and the Fed was set to raise them again.

However, by the end of the week, it became evident that Japanese authorities had prematurely sparked panic among carry traders as market sentiment dramatically shifted.

Most investors still don't expect any significant changes from the BOJ at its June meeting, a viewpoint supported by the International Monetary Fund's chief economist, Pierre-Olivier Gourinchas. On Thursday, he suggested that it was still too early for the Bank of Japan to tighten its monetary policy since achieving its inflation target would take time.

Market participants have shifted their projections regarding further tightening in the US this week, casting doubt on this prospect. Currently, futures markets are estimating the likelihood of the Fed raising rates this month at just 29%, down from nearly 70% a few days ago.

So, what triggered this change in market expectations? First, the weak macroeconomic data in the US, and second, unexpectedly dovish comments from Fed officials.

On Thursday, the Institute for Supply Management (ISM) released statistics on manufacturing activity for May. According to the report, the Purchasing Managers' Index (PMI) fell last month to 46.9, down from April's reading of 47.1.

US manufacturing has been contracting for seven consecutive months due to continued tightening in the country. This is a clear sign of a slowdown in the American economy and could be a strong argument for the Fed to consider pausing its rate hikes.

The market's hawkish expectations were also undermined by recent dovish rhetoric from Federal Reserve Board member Philip Jefferson and Federal Reserve Bank of Philadelphia President Patrick Harker.

Both policymakers expressed support for a pause in rate hikes at the next FOMC meeting, despite inflation's slow decrease. This stance led to a sharp decline in US Treasuries yields. On Friday night, the yield on 10-year bonds dropped to its lowest level since November last year at 3.57%, exerting strong pressure on the USD/JPY pair.

USD/JPY still has upside potential

Today's key trigger for the American currency will be the US NonFarm Payrolls (NFP) report for May. This report will help traders understand if a rate hike will occur in the coming months – in June or July, as highlighted by Barclay analyst Shinichiro Kadota.

If we rely on economists' preliminary estimates, further tightening in the US seems unlikely. A couple of weeks ago, experts predicted a noticeable slowdown in the US labor market in May (from 253,000 to 180,000), and also an increase in unemployment (from 3.4% to 3.5%).

However, yesterday's data from ADP, which serves as a fairly good indicator for the NFP report, showed that predictions can be wrong.

According to Automatic Data Processing's release, the number of jobs in the US private sector increased by 278,000 in May, significantly exceeding estimates of 170,000.

This suggests that the NFP change could also be quite solid. A stronger report will most likely reintroduce a hawkish scenario, providing substantial support for the US dollar on all fronts, including the yen.

But let's see what experts from the world's largest banks think about this. What do they forecast for the US NonFarm Payrolls?

Commerzbank:

"We expect that the US economy added 200,000 new jobs in May compared to 253,000 in April, and unemployment remained at the same level of 3.4%. Thus, we might see a moderate cooling in the labor market, which will clearly not be enough to noticeably reduce inflation."

Danske Bank:

"We expect to receive another relatively optimistic employment report in America, considering the latest data indicating healthy job growth. Based on this, we predict that the number of nonfarm employees in the US increased by a solid 200,000 in May."

TD Securities:

"US employment growth probably slowed slightly in May. We expect it to have increased by 200,000 for the second month in a row, and the unemployment rate to have remained unchanged at a historical low of 3.4%."

Societe Generale:

"We believe that job growth is slowing down, but the pace remains high. According to our forecasts, the number of nonfarm employees in the US increased by 210,000 in May, and the unemployment rate remained low at 3.4%."

Credit Suisse:

"We expect that the US economy added 200,000 new jobs last month, and the unemployment rate remained at 3.4%. Stronger US labor market data will help the Fed maintain its hawkish stance and inclination to raise rates, rather than cut them."

Citi:

"We expect that the reduction in available workers for hire may still limit the monthly increase in jobs, causing NFP dynamics to likely slow, but not significantly. According to our forecasts, employment increased by 200,000 in May, and the unemployment rate remained unchanged at 3.4%."

As we can see, fresh expert forecasts differ significantly from earlier consensus, which encourages the US dollar bulls. If today we receive evidence that the US job market remains strong, it will again bolster traders' hawkish expectations.

In this case, the dollar may show growth in many directions, but it will likely demonstrate the best dynamics paired with the yen, which continues to remain under strong dovish pressure from the Bank of Japan.

This morning, BOJ Governor Kazuo Ueda stated that the regulator would need some time to reach a target level of 2% and added that he could not provide any specific timelines for when exactly this would happen.

Mr. Ueda's latest comment is another proof that the Bank of Japan is not going to adjust its monetary policy and will leave all its parameters unchanged at the June meeting.

If the NFP report increases the likelihood of further enhancement of monetary divergence between Japan and the US, it could provoke another wave of USD/JPY purchases by carry traders.

Аlena Ivannitskaya,
Analytical expert of InstaForex
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