With the latest comment from Powell indicates that Fed is not rush in cut rate and prefer a 25bp cut in rest of 2024, the current probability of 50bp cut reduce to 35%. On the other hand, despite hawkish candidate Ishiba being elected as Japan's new Prime Minister, recent comments from BoJ Governor Ueda indicate that a rate hike is not imminent, suggesting the yen's bullish momentum from this political shift may be short-lived.

USD: Too early to see bearish

The USD narrative focuses on whether the Fed will cut rates by another 50bps in November, with traders pricing in about 62% odds of this. Recent PMI data, particularly from the services sector, points to resurging inflationary pressures, which could complicate the Fed’s efforts to hit its inflation target. Despite the Fed shifting focus more toward the labor market, core PCE data for August showed a modest 0.13% rise, in line with expectations, though the six-month annualized rate slowed to 2.4%, the lowest since December. While inflation is easing, it’s not yet sufficient for the Fed to claim victory in fighting inflation. September’s labor market data, including Non-farm Payrolls and ISM reports, will be crucial for assessing the Fed's next steps.

Despite the recent underperformance of the USD, market sentiment doesn’t anticipate a sustained decline, as the Fed could still manage a soft landing for the US economy. Historically, the USD tends to outperform G10 peers in such situations, making USD-denominated assets more attractive. With many Fed-related factors already priced in, it would take notably weak labor data or dovish surprises from Fed officials to push the USD lower, while strong labor data or economic resilience would likely support USD strength. The USD remains fundamentally strong, especially with the upcoming US election. A sharp deterioration in labor data would be required to change the outlook for USD bears. Additionally, election-related risks may deter investors from shifting away from the USD, providing further support. The overall outlook for the USD remains cautiously bullish, with key risks tied to labor market performance and Fed policy decisions.

Looking ahead, the focus will be on Non-farm payrolls, labor components of the ISM reports, and upcoming Fed speeches. With many negatives already priced into the USD, weak labor data or dovish Fed signals could pressure the currency. However, signs of a resilient economy and labor market or differing opinions within the Fed on future rate cuts could help the USD consolidate its position.

JPY: New Prime Minister

The yen's gradual strengthening is progressing in the right direction but at a slower pace than market expectations, largely due to the ongoing expansion in the U.S. economy and the reduced likelihood of an imminent recession. A rapid yen appreciation would undermine the Bank of Japan's (BoJ) goal of achieving sustained positive inflation. BoJ Governor Kazuo Ueda recently reiterated that the bank is in no rush to raise rates and will take time to assess domestic developments, which contributed to pushing USD/JPY higher. This aligns with his previous dovish comments, indicating that upside risks to inflation are easing, reducing speculation of a rate hike at the upcoming 31 October BoJ meeting. Absent any major surprises in U.S. data, the likelihood of USD/JPY dropping below 140 in the near term appears low. Instead, with a gradual Fed recalibration and the BoJ likely tightening only in 2025, USD/JPY may rise in the short term.

In addition, Shigeru Ishiba has won the LDP leadership race and will become Japan’s next prime minister, which is positive news for yen bulls. Ishiba, known for supporting continued BoJ rate hikes, could further bolster expectations for a stronger yen. However, given Ueda’s recent comments that a near-term hike is unlikely, the bullish momentum for the yen from this political shift may be short-lived.

Looking ahead, Japan's Tankan survey, industrial production, and retail sales data will be crucial for the yen, potentially indicating that the economy is not yet ready for further rate hikes. However, the most important driver for the yen in the coming week will be U.S. economic data, particularly labor market figures. Strong U.S. data could reduce expectations of steep Fed rate cuts, weighing on the yen. Investors should also keep an eye on U.S. presidential election opinion polls, as a surge in Kamala Harris' odds could also support a USD/JPY bounce.

USD/JPY 4H Chart

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