USD/JPY pares recent highs amid talks of Fed rate cuts

The US dollar weakened after expectations for Fed rate cuts later this year began to surface on Wall Street.

The USD/JPY is trading around ¥110.375 as of 6.45pm SGT on Wednesday 26 February, a drop of around 1.7% from fresh highs recorded late-last week.

The pair has been trading sideways for the better part of the last 24 hours, averaging around ¥110.300.

Greenback went sub-110.000 on interest rate-cut talks

Last Thursday 20 February, the forex pair hit a ten-month peak when it rose to ¥112.216. That level, however, was short-lived, with the US dollar (USD) sliding back under ¥110.000 on Tuesday 25 February.

FX analysts from UOB said this was because of growing expectations around the fact that the US central bank would cut interest rates by 25 basis points in June this year to relieve pressure on the economy caused by the COVID-19 outbreak.

When interest rates fall – as in this case, demand for a country’s currency tends to fall as well, as investors hold less of a currency since there is less benefit to putting their money in the country’s banking system. This leads to a decline in currency value.

Nevertheless, US Fed officials have indicated that ‘it is still too soon to even speculate about either the size or the persistence of these effects, or whether they will lead to a material change in the outlook’.

IG Asia market strategist Pan Jingyi said that ‘selling into the month-end might have also exacerbated the decline’.

‘This had coincided also with gold prices gains, suggesting that some profit taking might be the case,’ she added.

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Widening spread of COVID-19 raises ‘fresh aversion’

The rapid spread of the virus beyond China in countries like Iran, South Korea, and Italy over this past weekend, had raised new concerns and fears in global financial markets at the start of the week.

As Pan also wrote on Monday, the jump in coronavirus cases had ‘sparked off a fresh round of risk aversion’, and the issue ‘had suddenly taken a more global turn into this week’.

Adjustments appear to have kicked into place for the US market, despite the relative insulation from the rest of the world perceived thus far, she added.

US equities, for instance, sunk on Tuesday, with the Dow Jones Industrial Average losing 879.44 points, equivalent to a loss of 3.15%, to end at 27,081.36. This was the first time the benchmark has ever posted losses of at least 800 points on back-to-back days.

The US Treasury note – also viewed as a less risky asset like the USD – also a record-low yield on Tuesday on the back of COVID-19 concerns and soft US GDP estimates for the first quarter of 2020.

Flipside: investors returning to safe-haven yen

Pan said that the yen could also be strengthening as a reflection of the increased risk sentiment, since the rise has coincided with reports of new coronavirus cases.

This reinforces yen’s reputation as a safe-haven currency to some extent, she added, just as markets were beginning to have their doubts about the fiat money. That's because Japan has the highest number of confirmed COVID-19 cases (over 800) outside of China.

Analysts at US financial services firm Action Economics shared the same sentiment, stating that investors and traders might be overlooking the yen’s traditional risk-free qualities.

‘In the scheme of things however, given risk-off conditions, and heightened coronavirus concerns, USD/JPY has held up relatively well,’ the analysts wrote in a note.

‘There was talk last week of early portfolio flows into the dollar ahead of Japan’s fiscal year end on 31 March, with pension funds rumoured to have been big buyers. These flows may continue, and despite the current risk-averse conditions, may limit USD/JPY downside for now.’

Downsides to be expected

Still, the higher levels of risk aversion and volatility at present has Pan believing that downsides are to be expected in the coming days.

UOB analysts also noted that there are yet to be any signs of stabilisation for the US dollar, with further weakness still a possibility. ‘From here, USD could continue to trade in volatile manner but is expected to stay to within last week’s broad 109.64/112.21 (range) for a while,’ they wrote.

Certainly, the pair is beginning to inch up again, making volatility the only constant at this point, and any bold predictions a difficult ask.

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