USD/JPY reverses lower as risk appetite weighs on US yields, bounces at key 112.50 support

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Abstract：USD/JPY fell back to weekly lows in the 112.50 region on Friday though has since bounced as volumes fade. The pair reversed from as high as the 113.50s as risk appetite deteriorated and drove long-term US yields lower.

　　Risk-off is the driving force as the US session draws to a close. US stocks are substantially lower, as are other risk assets like crude oil and the likes of AUD, NZD, NOK and SEK in foreign exchange markets. Safe-haven US bonds, meanwhile, have caught a bid and this has pushed yields significantly lower and further flattened the US curve. This has put downwards pressure on US/Japan rate differentials and, as a result, is weighing heavily on USD/JPY.

　　Back to bonds; the 10-year yield is down 10bps on the day to under 1.35%, while the 2-year is down about 3bps to just under 0.60%. The latter remains elevated given this week‘s hawkish Fed shift, which has been to an extent endorsed by a string of strong US macro data releases culminating in Friday’s mixed but broadly interpreted as solid, labour market report. On the week, 2-year yields are up nearly 10bps.

　　Meanwhile, longer-duration US yields are down sharply on the week as traders worry that the emergence of Omicron at a time when the Fed is set to start withdrawing stimulus will result in weaker growth/inflation down the line. 10-year yields are down about 15bps on the week. The divergence has seen the 2s/10s spread narrow to its lowest point in 2021 at around 75bps, a near 25bps drop on the week.

　　Looking more closely at USD/JPY then; the pair has bounced in recent trade after probing earlier weekly lows in the 112.50 area earlier in the session. The pair currently trades around 112.75, marking a sharp, risk-off fuelled turnaround from earlier session highs to the north of 113.50.

　　Forgetting about Omicron for a second, fears are growing that the US will soon follow in the footsteps of the sharp spike in Covid-19 infections seen in Europe over the last few weeks. The emergence of Omicron makes such a spike in infections more likely and another spike in cases risks a sporadic reimposition of lockdown restrictions in various states.

　　These are all factors being fretted over by market participants and risks that seem unlikely to fade any time soon. If risk-off rather than central bank policy divergence remains in the driving seat for bond and FX markets in the coming weeks as a result, USD/JPY could well break lower towards 112.00.