USD/JPY Forecast: Energy overtakes rates as bearish signal emerges

• USD/JPY flashes bearish signal at multi-week highs
• Energy overtakes rates as dominant driver
• Strong US data curtails Fed easing bets
• February nonfarm payrolls the key risk ahead

Summary

USD/JPY was given every reason to continue rallying on Wednesday but couldn't: hot US economic data again dismissing fears about a growth slowdown seen late last week, another curtailment in Fed rate cut pricing this year, and a sharp recovery in risk appetite. Instead, it bucked the traditional playbook, delivering a bearish reversal signal on the daily timeframe, strengthened by the fact it arrived after the pair traded at fresh multi-week highs.

Based on recent relationships, the lack of any further advance in energy prices may have provided the catalyst, but can the signal be trusted in an environment where narratives and headlines are shifting by the hour, with a clear bias towards latching on to those offering good news rather than bad?

Bearish reversal raises questions

Source: TradingView

You can see the price has done a lot of work either side of 157.88 which was the swing high set in November last year. It's acted as both resistance and support since then, including this week when the rally off the lows set in February stalled after failing to deliver a clean break above it. The bearish engulfing on Wednesday is as clear as day, and looking at recent price action in the pair after engulfers were printed following sustained upswings, it makes you sit up and pay attention.

At face value, it suggests downside risks are building, potentially threatening the uptrend the pair has been in since the middle of February. But can it be trusted? Risk appetite has rebounded and will likely extend into Asian trade on Thursday, energy supply concerns have not disappeared even though the rally in energy markets has stalled for now, and the US rates outlook is looking rock solid.

Follow-through price action to confirm the bearish signal is needed in my book before buying into the short thesis, excuse the pun. Downside levels to watch include 156.83, the high from Feb 25, along with the Feb 17 uptrend, the 50-day moving average and 155.64 support.

On the topside, the prospect of a false signal keeps a retest of 157.88 in play, with a clean break of that level opening the path for a run towards the 2026 high of 159.45.

RSI (14) and MACD are not delivering as definitive a message as price action has in recent weeks, with the former breaking its modest uptrend and now sitting just above the neutral 50 level. MACD has made its way back into positive territory having already crossed the signal line from below, meaning the overall bias is mildly bullish at this point. Again, another reason to question the bearish price signal delivered overnight.

Energy now steering USD/JPY

Source: TradingView

Looking at recent relationships, there has been some linkage between USD/JPY and Fed pricing, front-end US rates and near-dated yield differentials between the US and Japan. But over the past week it’s really been the energy complex doing most of the heavy lifting, something reflected in the strength of the correlations seen.

That makes sense given the geopolitical backdrop.

Narratives shift as markets hunt good news

The rally in crude and gas stalled early in the European session on a report claiming Iranian intelligence agents used intermediaries to ask the FBI what would be necessary to end the conflict. The problem is the request was apparently made the day after the conflict began, meaning Sunday, and was later denied by Iran. Markets didn’t seem to care. They latched onto it and ran with it.

There was also speculation that fewer Iranian missile launches may indicate the regime is running short of projectiles. Again, a very long bow being drawn there, but it shows markets are keen to latch onto good news while dismissing the bad.

As long as that continues, and given Japan’s status as an energy have-not, it would seemingly favour the yen. But if tensions escalate again, it points to upside risks for USD/JPY.

Hot US data curtails Fed easing bets

While energy appears to be the dominant driver right now, the rates regime may not remain in the background for long.

The latest run of US economic data was undeniably strong. Even though there was some evidence of job shedding in professional services in the ADP report, with large employers barely adding to payrolls and job growth concentrated in small businesses and the education and healthcare sectors, the broader message was one of resilience.

That was reinforced by the ISM services report which delivered another strong set of readings. The headline index jumped to the highest level since mid-2022, while new orders surged and the employment gauge pushed back further into expansion territory, suggesting demand and hiring intentions across the services sector remain healthy.

Source: TradingView

Markets have responded accordingly. Fed funds futures now price just 40 basis points of easing this year, the least amount seen in months. There is effectively no prospect of a rate cut in the first half of the year, with nothing priced for March, only a 16% probability of a reduction in April and around a 37% chance by June.

Apart from initial jobless claims due later Thursday, the key known risk event remaining this week is also the biggest: February nonfarm payrolls. I've detailed the data in separate reports which will be linked within this piece. Further insights on what to expect can be found here in a separate report.