USD/JPY, Nikkei 225: Fed’s dovish disappointment sees Japanese markets take flight

• Fed signals 200 basis points of rate cuts by end of 2025, less than markets had priced
• Traders have marginally curtailed rate cut bets, lifting US yields
• Pickup in US rates has helped spark a reversal in USD/JPY
• Weaker yen is boosting sentiment towards Japanese exporter earnings

Overview

USD/JPY and Nikkei 225 futures are surging in Asia, benefitting from a market recalibration of how much the Federal Reserve is likely to cut interest rates next year. The weaker yen is helping to boost sentiment surrounding Japanese exporter earnings, seeing Japan’s benchmark equity index knocking on the door of key resistance.

When 200 is not enough

While the Fed went big to start its easing cycle, delivering a 50 basis point cut to take the funds rate down to a range between 4.75-5%, it’s what it signalled on the pace of rate cuts next year that had a greater market impact with the median FOMC forecast looking for 100 basis points of cuts, signficantly less than markets had priced in. 

Here’s the latest Fed forecasts, showing 200 basis points of cuts expected by the end of 2025.

Source: Federal Reserve

This chart shows that while market pricing for rate cuts this year remain higher than what the Fed is signaling, the degree of easing priced next year has been curtailed slightly as a result of the updated projections.

That’s proven to be very influential for Japanese markets today.

As US-Japan yield differentials widen, USD/JPY reverses hard

The next chart shows that as Fed rate cut bets have been curtailed, yield differentials between the US and Japan have started to widen again across two, five and 10-year tenors, helping to spark a reversal in USD/JPY.

And that’s boosting the Nikkei 225

We know yield differentials are influencing USD/JPY based on the rolling 20-day correlation analysis below. Take note of the bottom pane which reveals the relationship with Nikkei 225 futures has also been strongly correlated. Where USD/JPY has moved, Nikkei has often followed.

USD/JPY stages bullish breakout

Applying the key market drivers to the technical picture, you can see USD/JPY has staged a bullish breakout from minor downtrend resistance, pushing up to test 143.70. With RSI (14) and MACD generating bullish signals on momentum, a clean break above this level could see the pair push back towards resistance at 147.06.

Buying dips is favoured over selling rips near-term, although the proximity of the price to 143.70 does provide a level to build trade setups around.

One option is to buy above the level with a stop below for protection, targeting 147.06. Alternatively, if the price fails to hold the level, you could sell with a stop above for protection. The former downtrend and 140.273 loom as potential targets.

Nikkei 225 futures testing key level

With USD/JPY ripping higher, Nikkei 225 futures have also staged a bullish breakout, busting out of the symmetrical triangle it had been trading in dating back to early September.

Right now, it is testing an uptrend that dates back over a year, with a break above likely to see a retest of the important 50-day moving average. With RSI (14) breaking out and MACD about to confirm the bullish signal, there’s a growing risk we may venture higher. Volumes for this early stage of the session are also decent, indicating the move may have legs.

Depending on how the price interacts with the uptrend, traders can use the level to establish bullish or bearish setups, allowing for a stop to be place on the opposite side to entry for protection against reversal.

-- Written by David Scutt

Follow David on Twitter @scutty