JPY: Positive Risk Appetite Curtails Dollar Demand

The recent trajectory of the US dollar has been marked by notable fluctuations, with last week's impressive rebound, almost fully recouping the losses of the preceding week. However, as the new week commences, the greenback finds itself on the defensive, facing moderate selling pressures, particularly in anticipation of the pivotal US Consumer Price Index (CPI) data for October. This data is expected to play a decisive role in shaping the near-term outlook for the USD, with market participants keenly observing its implications on the currency's value.

Going to Asia, the yen's performance has been intriguing. While it exhibited weakness for a substantial part of yesterday's trading session, a sudden and unexpected surge reversed the trend. This abrupt movement led to speculations about possible intervention, prompting market participants to closely scrutinize Finance Minister Suzuki's remarks. While Suzuki did express concerns about yen weakness, the comments appeared to be within the realm of the usual discourse. The lack of sustained movement in USD/JPY following a new intra-day high of 151.91 raises questions about the nature of this surge, suggesting that it may be more attributable to option-related selling rather than intervention by Japanese authorities.

The trajectory of USD/JPY continues to be heavily influenced by yield dynamics, with the week-on-week change in the currency pair closely correlated with the corresponding change in the US Treasury (UST) bond 2-year yield. This intricate relationship underscores the importance of yield movements in shaping the direction of the currency pair.

The key question is whether the data will propel USD/JPY to break higher, surpassing recent highs and reaching the cyclical peak recorded last year at 151.95, representing a 33-year high. The anticipated decline in the headline CPI rate, driven by falling gasoline prices, is expected to result in an annual rate drop from 3.7% to 3.3%. This would mark the first deceleration in the annual rate since June. In contrast, the core rate is projected to remain at 4.1%, underscoring the Federal Reserve's persistent concerns about underlying inflationary pressures.

However, a nuanced analysis is necessary to discern the sources of upward pressure before drawing conclusions about potential Federal Reserve policy implications. Medical care services are anticipated to be a significant driver, particularly with the Bureau of Labor Statistics recalculating health insurance annually, setting it at that rate for the subsequent year. After acting as a drag over the past 12 months.

In assessing the broader economic landscape, the Federal Reserve received a dose of positive news recently. The New York Fed's measure of inflation expectations demonstrated a decrease of 0.1 percentage points to 2.7% over 5 years and 3.6% over 1 year. This contrasts with the sharp increase in the University of Michigan's inflation expectations observed last Friday. The stability in the 3-year measure at 3.0% adds another layer of complexity to the inflation expectations narrative.

Despite this, it's worth noting that a considerable upside surprise, particularly related to medical services inflation, would be required to prompt markets to reevaluate their expectations of Federal Reserve rate hikes. It's anticipated that any resulting strength in the US dollar would be most pronounced in USD/JPY, especially if option-related resistance at 152.00 is breached.

In conclusion, the interplay between various economic indicators, geopolitical developments, and market dynamics is shaping the trajectory of the US dollar, particularly in the context of USD/JPY.

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