(Click on image to enlarge)

For the past two weeks investors have been scratching their heads over the sharp sell-off in USD/JPY. Data has been good, the U.S. economy is improving and practically every Federal Reserve official who had an opportunity to speak said rate hikes are coming. So why has the U.S. dollar struggled to rally? The answer lies in expectations – the media has been talking up the possibility of a March rate hike and investors are just not convinced that it will happen so quickly. U.S. yields have fallen sharply (over 6bp at one stage on Friday) with Fed fund futures pricing in only a 40% chance of a rate hike next month. There’s clearly a misalignment between what the data is showing, what the Fed has been saying and what the market believes. We think the dollar should be trading higher but there’s no question that investors need more convincing. This could come in the form of an aggressive tax cut plan from Trump that provides the fiscal stimulus that everyone is waiting for, a hot non-farm payrolls report and/or clearer guidance from the Fed leadership but it will come eventually.

Technically USD/JPY appears very weak and likely to test the February lows near 111.60, which is right below the 100-day SMA. The latest sell-off has taken the pair below the 50% Fibonacci retracement of the 2015 to 2016 sell-off which makes the test of support likely. However further losses beyond that should be limited by the fundamental outlook for the currency.