- USD/JPY defended key support at 148.65, bouncing into month-end
- Yield spreads collapsed, but the yen failed to capitalise
- Markets now fully price two Fed cuts in 2025, with a third in play
- U.S. payrolls and Powell’s speech could drive major volatility
- Technicals turn neutral, with resistance at 151, 152.43, and 153.38
Summary
Downside risks flagged previously played out nicely for USD/JPY, resulting in the pair testing the December 2024 low before bouncing into month-end. While interest rate differentials remain the dominant driver, the grip has weakened recently, putting more emphasis on technical considerations. On that front, the price action appears far more neutral relative to prior weeks, although fundamentals point to directional risks remaining skewed to the downside. Whether that plays out in practicality may be determined on Friday with U.S. non-farm payrolls and speech from Fed Chairman Jerome carrying the potential to deliver significant volatility.
U.S. Growth Outlook Darkens
U.S. economic exceptionalism is under threat, undermined by increasingly spluttering consumer data. That can be seen firsthand in Citigroup’s economic surprise index with data undershoots now the most prevalent since September. The negative reading indicates more data than not is disappointing on the downside, a trend in stark contrast to Japan where the prevalence of data beats now sits at the most elevated level since May.
Source: Refinitiv
More Cuts, Lower Yields
The fragile economic picture in the United States has driven a noticeable shift when it comes to the interest rate outlook. Whereas futures markets were looking for only one cut from the Federal Reserve in 2025 only a few weeks ago, now two cuts are fully priced with a third deemed a coin flip.
Source: TradingView
The shape of the US 2s10s curve—which is simply 10-year yields less two-year yields—has flattened noticeably as economic data has rolled over, indicating traders are paring expectations for U.S. growth and inflation in the future. As a result, benchmark 10-year Treasury yields have plummeted.
Rates, FX Abruptly Disconnect
The latter is extremely important for USD/JPY when you consider how influential interest rate differentials remain when it comes to directional movements. Over the past month, the correlation coefficient between USD/JPY with 5-year and 10-year interest rate differentials between the United States and Japan stands at 0.79 and 0.84 respectively. That means the two have often moved in the same direction.
Source: TradingView
However, it’s noticeable the collapse in yield differentials last week didn’t deliver a meaningful unwind in USD/JPY, hinting factors other than rate spreads were in play. Perhaps it was month-end capital flows or related to looming U.S. tariffs on imports from Canada, Mexico and China scheduled to come into effect on March 4. Looking at the price action, technical considerations may explain the divergence from rates.
USD/JPY Technical Picture Shifts Neutral
Source: TradingView
As flagged in our prior outlook note, USD/JPY did retest the December 2024 swing low of 148.65 on multiple occasions last week. However, the bulls were clearly in no mood to cede further ground to bears, stepping in to defend the level. The price action was reflective of a market trying to carve out a near-term bottom, eventually delivering a morning star three-candle pattern which may have contributed to the late surge seen on Friday.
Demonstrating just how respectful the price has been of known levels recently, the only change I had to make the chart this week was to extend the downtrend from the January highs.
Resistance can be found at 151, 152.43 and 153.38. Support is located at 148.65 and 147.20. Momentum signals are starting to flick higher, indicative of a neutral bias.
Payrolls & Powell Headline Event Risk
Aside from tariff-related headlines and news flow, event risk is elevated this week with plenty of data and central bank speeches that carry the potential to deliver meaningful two-way volatility in USD/JPY. Times reflect Japan Standard Time. 
Source: Refinitv
Friday’s payrolls report is the undisputed headline act, especially at a time when concerns around the consumer are elevated. Even though it’s referred to as “payrolls”, it really is the unemployment rate that matters most given that’s what the Federal Reserve is graded on. That means if there’s a divergent message between the payrolls and unemployment figures, it’s likely to be the latter that markets eventually gravitate towards. Before payrolls shakes things up, keep an eye on the ISM manufacturing and services PMI reports—already well known as market drivers, the influence may be even stronger on this occasion, especially if significantly weaker.
Source: Refinitiv
Amplifying the potential for volatility on Friday, several influential Federal Reserve members will speak following the payrolls report, including Jerome Powell. Any hint of the Fed tilting dovish again could spark a sudden downside flush in USD/JPY.
Beyond known risk events, volatility looms with the scheduled March 4 implementation of 25% tariffs on Canadian and Mexican imports and an additional 10% on Chinese goods. With markets only partially pricing in the risk, whether they proceed as planned could materially impact USD/JPY. If history is a guide, the US dollar may strengthen if the levies take effect.