USD/JPY at a crossroads ahead of Warsh’s Jackson Hole speech

USD/JPY is holding around 159.20, trading within a narrow range as investors continue to assess the latest U.S. inflation data and the outlook for both the Federal Reserve and Bank of Japan.

The USD has recovered from a three-month low after data showed that inflation remains elevated, while stronger consumer spending and GDP-related data have also improved the growth outlook. However, the recovery has stalled ahead of Federal Reserve Chair Kevin Warsh's speech at Jackson Hole on Friday.

US inflation was slightly hotter than expected

Annual PCE inflation remained at 3.7% in July, above forecasts of 3.6% and above the Fed's 2% target for the 56th straight month. Core PCE, the Fed's preferred gauge of inflation, also remained at 3.3%, while monthly core PCE accelerated to 0.2% from 0.1% in June.

At the same time, stronger consumer spending and core durable goods shipments point to solid Q3 growth, potentially around twice the 1.5% growth recorded in Q2.

That combination of sticky inflation and stronger growth makes it harder for the Fed to justify easing policy and has modestly increased the chances of a rate hike in September. According to the CME FedWatch tool, markets are now pricing around a 40% probability of a hike, up from 36% before the data. Treasury yields and the dollar have responded accordingly.

Warsh could be the next major catalyst

Attention now turns to Kevin Warsh's first keynote speech as Fed Chair at Jackson Hole on Friday.

Markets will be listening for how firmly he commits to getting inflation back to 2% and, more importantly, how the Fed intends to respond if price pressures remain elevated while growth stays resilient.

Warsh's preference for limited forward guidance means he may not give markets the clear signal they are looking for. But that could make even relatively small changes in his language important, particularly with expectations for September still finely balanced.

A more hawkish Warsh would support Treasury yields and the dollar, offsetting recent debasement trade concerns and increasing the chances of USD/JPY breaking above 160. A more cautious message could have the opposite effect, particularly if markets start to question whether the Fed will actually hike this year.

BOJ expectations are rising

The other side of the trade is becoming increasingly important.

Markets are now pricing around an 87% probability of a 25-basis-point BOJ hike in September, which would take rates to 1.25%. That's a sharp increase from around 23% before the Bank of Japan's July meeting.

Former BoJ board member Seiji Adachi has also said the central bank is likely to raise rates next month, with another hike potentially coming in January.

This creates a much more interesting setup for USD/JPY. U.S. data is making a Fed hike more plausible, while Japanese policy expectations are also moving towards tighter policy. The next sustained move in the pair will therefore depend on which side of that policy gap moves further.

Tokyo inflation will be important here. Core CPI is expected to ease to 1.7% from 1.9%. A weaker reading could see markets pare back BoJ hike expectations, giving USD/JPY room to push higher.

However, if inflation remains firm, the market could become even more confident that the BOJ will hike, increasing the pressure on USD/JPY.

For now, 160 remains the key level. A hawkish Warsh alongside softer Tokyo inflation could open the door to a break higher. But if Warsh is cautious and Japanese inflation remains firm, the risk increasingly shifts towards a pullback.

USD/JPY technical analysis

USD/JPY recovered from the 155.20 low, pushing back above the 200 EMA. However, the recovery has stalled around 159.5, the 50% fib retracement of the 164 high and 155.20 low.

Buyers would need to rise above 159.5 and the 160 resistance zone to be on a firmer footing and head toward 162, the 78.6% Fib level, before attention turns toward 164. 

On the downside, initial support appears at 158.50, the 38.2% Fib level. Beyond here, the 200 EMA is at 158. Should sellers break below this level, the outlook turns more bearish. After another support at 157.20, the 23.6% Fib level, attention turns to 155, the May and August low.