USD/JPY Forecast: Falling channel intact despite bullish engulfing pattern

The Dollar-Yen pair clocked a low of 112.57 in the Asian session on Wednesday before rising to as high as 114.76 levels by the late North American session. The uptick in the treasury yields coupled with the unwinding of the shorts helped Wednesday’s candle engulf/undo the losses suffered on Tuesday.

The data released in the US showed inflation rose in 2016 at a fastest pace in 2016. The rise in gasoline prices raised the overall inflation. The gas prices surged 9.1% last year and rents increased 3.7%, the largest advance since mid-2007. The CPI rose 0.3% in December as expected, while the core CPI jumped 0.2%.

Fed’s Yellen - Slightly dovish than expected

Yellen did not move markets in a major way, but sounded slightly dovish. She acknowledged dollar’s influence on the economy Moreover; the markets are more sensitive to remarks about the strong USD after Trump expressed concerns regarding the same.

Yellen said Wednesday that "waiting too long to begin moving toward the neutral rate could risk a nasty surprise down the road - either too much inflation, financial instability, or both."

Despite stating the Fed is closer to its goal, Yellen backed-off from making hawkish predictions and added the next rate hike depends on the economy over the coming months.

We can conclude that the stage was set for more hawkish stance, but as El-Erian said, “she didn’t go there”. Still, the American dollar rallied and that could have been due to the upbeat inflation number.

ECB could derail the dollar recovery

Taper talk is taboo and despite the surge in energy prices, the headline inflation still remains well below the ECB’s 2% target. Nevertheless, there is little reason as of now for Draghi to sound ultra dovish. Furthermore, markets addicted to dovish Draghi could be caught off guard by hawkish commentary regarding inflation and that could lead to a surge in EUR/USD and broad based losses in USD.

EUR/JPY could turn out to be a strong performer in this case; however, the Dollar-Yen pair could feel the weight of the broad based USD weakness.

US weekly initial jobless claims number and the monthly housing starts and building permits could be overshadowed by the ECB rate decision unless the actual figures show a significant improvement/deterioration.

Technicals - Channel resistance of 115.35 could be put to test

4-Hour Chart

Daily Chart

• Wednesday’s bullish engulfing pattern coupled with a daily close above the upward sloping 50-DMA suggests the spot is on track to test the falling channel hurdle of 115.35 levels.
• A daily close above 115.35 would mark the end of the correction and open doors for 116.04-116.55 levels.
• On the other hand, failure to take out 115.35 followed by a drop below 114.54 (23.6% of Trump rally) would shift risk in favor of a re-test of 112.50 levels.