[ForexNews]

US$/JPY rises when the market prices in more tightening for the Fed and falls on the reverse. While most US-Japan interest rate differentials co-move with US$/JPY, the relationship between spot and the fourth rolling Eurodollar contract has been particularly strong over the past two and a half years. Indeed when US$/JPY rapidly appreciated to 85 on US thanksgiving day, thin liquidity and risk aversion over developments in Dubai were cited as the contributing factors; however, the shift in US rate expectations after the Fed elaborated on the underpinnings of ‘extended period’ also argued that US$/JPY could trade lower than it had been.

Market expectations that the Fed will keep interest rate settings unchanged over the next 2 years points to the possibility that US$/JPY could remain anchored around 90 (in a range of between 85-95) over the next 12 months if not longer. Given that the market discounts Fed rates at 2.25% by end 2011, but only 30bps for the BoJ, a continued repricing of US rate expectations could push the Yen stronger vs. the Dollar compared to where it currently trades – revisiting 85 again in spot is not impossible.