US dollar down on government shutdown, but could it rebound anyway?

The market’s main focus remains fixated on developments in Washington. The dollar has started the new week on the back foot as US politicians failed to break a stalemate on a stopgap bill needed to fund the government at the weekend. As a result, the shutdown has dragged into its third day, raising doubts over a March Federal Reserve rate hike. The uncertainty has also weighed on stocks with US index futures being slightly lower at the time of this writing. The fact that neither the dollar nor the stock markets have sold off heavily yet means investors are probably still hopeful – maybe rightly so – that there will be some sort of a resolution in Washington soon. If that’s proven to be the case then we could see a speedy recovery in both markets. Meanwhile the economic calendar is quite quiet today, which means the focus will remain on Capitol Hill. But the rest of the week will be busier as we will have Bank of Japan and the European Central Bank rate decisions, as well as a few important macro pointers to look forward to.  

Will Bank of Japan help relieve pressure on the dollar?

The Bank of Japan will issue its interest rate decision and monetary policy statement, and hold its press conference on Tuesday. The markets will be watching closely for any signs that the central bank may be looking to wind down its stimulus programme at some point in the foreseeable future after it unexpectedly reduced its purchases of Japanese government bonds recently. Speculators saw this a sign that the central bank may be leaning towards tighter monetary policy. Any further indication on Tuesday of stimulus reduction or an otherwise more hawkish Bank of Japan, could result in another boost for the yen. However, if the BoJ dismisses the importance of that QE taper and reaffirms that it will maintain its policy open wide then the yen could weaken as Japanese stocks probably march further higher. The resulting risk-on rally and yen weakness could boost the risk-sensitive USD/JPY pair. The latter could find additional boost from Capitol Hill, should US politicians sort out the mess they have created.

USD/JPY tests key support

So, there is a good possibility the USD/JPY may bounce back in the coming days. However from a purely technical stand point, price action is far from being bullish at the moment. But at around the 110.50 area, the USD/JPY is testing a key support zone anyway. The bulls would like to see a low form here, while the bears would be looking for a breakdown. Depending on which group of market participants will win the battle here, we could see a sizeable move in the direction of the break in the coming days. The short-term bias could turn bullish if and when the USD/JPY goes back above the most recent high at 111.45, for then we will have a short-term higher high in place. For the bears, meanwhile, a close below 110.00 could be the trigger that they need.

Source: eSignal and FOREX.com.