USD / JPY rises sharply to test 21-day SMA at 113.80, hot US inflation increases pressure on Fed

• USD / JPY has rebounded sharply from Asian session lows below 113.00 and is testing its 21-day SMA at 113.80.
• An increase in US yields after inflation data is widening the rate differential between the US and Japan, driving the pair higher.

The pair USD/JPY continues to rebound from its weekly lows below the 113.00 level and now, following a much hotter than expected US consumer price inflation report, tests its 21-day moving average at 113.80. The pair is now up about 0.8% on the day, its best daily performance in a month.

The movement is being driven primarily by a sharp rally in (nominal) US bond yields as investors raise expectations that the Fed will be more aggressive in rate hikes to combat inflation and as investors flee from assets whose value is eroded by inflation (such as nominal bonds). 2-year yields are up 9bps at 0.50% and 5-year yields are up more than 10bps on the day above 1.17%. That compares to a rally of just over 1bps in 30-year performance.

Either way, higher yields and expectations of a stronger Fed response to inflation have given the rate differential between the United States and Japan a considerable boost. USD / JPY is highly sensitive to rate spreads and is therefore recovering as a result. As Increases pressure on the Fed to abandon its current position that rising inflation is transitory, and therefore does not warrant a monetary policy response, investors should be on the lookout for any signs that the bank could change policy in an optimistic direction. Any sign would send US short-maturity yields even higher, put further upward pressure on the US-Japan rate differential, and likely push USD / JPY back to yearly highs.

If USD / JPY is able to break above its 21-day SMA, it will open the door for a move to the 114.00 level. already recent highs just above in the region of 114.20-114.40. Bullish technical charts may be pointing to a return to yearly highs just above 114.60.