As the new week starts, the dollar/yen pair has interrupted its 3-day streak of gains and began a downward correction. What is the reason behind this pullback and can the pair resume its impressive rally in the coming days?
USD holding the trump card
By the end of the previous week, the US currency appreciated more than 2% against its Japanese counterpart, hitting a new seven-month high at 143.76.
A sharp surge in USD/JPY was primarily due to traders refocusing their attention on the stark difference in the monetary policies of the Federal Reserve and the Bank of Japan.
Currently, the key rate in the US ranges between 5.00% and 5.25%, and it could potentially increase further over the next few months. Almost half of the traders surveyed in a recent Bloomberg poll anticipate the Fed to raise its key rate at least two more times this year, while only 19% believe the tightening cycle in the US is over.
This shift in market forecasts is noteworthy given that until recently, most investors were convinced of an imminent monetary U-turn by the US central bank. So, what has solidified their hawkish stance?
Firstly, the updated dot plot published a few days ago played a significant role. The dot plot showed that FOMC members revised their expectations for the peak interest rate upwards (from 5.1% to 5.6%).
Secondly, Federal Reserve Chair Jerome Powell's hawkish rhetoric had a substantial impact. Last week, he appeared before the US Congress to present a report on monetary policy. Discussing the prospects of monetary policy with lawmakers, Powell stated that the regulator intends to continue fighting high inflation by raising rates. He didn't rule out the possibility of additional tightening rounds this year but cautioned that the pace of rate hikes would be more measured.
Essentially, the Federal Reserve Chair supported his colleagues who currently forecast two rate hikes of 0.25%. This gave momentum to the US dollar across the board, with the USD/JPY pair being the main winner.
By Friday, the pair had closely approached the level of 144, which currently stands as the primary strategic goal of the dollar bulls.
The greenback got major support from increased hawkish expectations regarding the future course of the US central bank. In addition, dovish remarks from BOJ members acted as a strong tailwind for USD/JPY.
At the last meeting held on June 15–16, the Bank of Japan maintained its ultra-low interest rate (at -0.1%) and made no changes to its yield curve control policy.
In addition, Japanese officials notably ramped up their dovish rhetoric last week. On Wednesday and Thursday, several BOJ representatives, including its head Kazuo Ueda, clearly indicated their intention to maintain the current monetary policy in the near term
Another blow to the Japanese yen came last Friday, with the publication of Japan's inflation data. The nationwide consumer price index fell from 3.5% to 3.2% last month, while the market had projected a further rise to 4.1%
This sudden slowdown in Japan's inflation means that the Bank of Japan (BOJ) is unlikely to take a hawkish turn or increase interest rates in the near future. This could potentially intensify the monetary divergence between Japan and the US, further exacerbating the yen's weakness.
The majority of analysts believe that the USD/JPY pair may continue its impressive rally this week if Jerome Powell gives hawkish signals to the market. The Federal Reserve Chairman's speech is scheduled for Thursday, June 29.
Another key trigger for the currency pair will be the publication of the Personal Consumption Expenditure (PCE) price index for May, which is due this Friday. The PCE is the Federal Reserve's primary inflation gauge for adjusting its monetary policy.
At present, economists predict that the indicator will remain steady. Persistent inflation in the US consumer sector could further reinforce expectations of additional tightening measures, which should support the US dollar, especially against the Japanese currency.
In the best-case scenario, the greenback could strengthen against the yen to the 145 level by the end of the week.
Risks on the rise
Despite a steady uptrend in the USD/JPY pair, the instrument showed its first decline in four sessions on Monday morning. At the time of writing, the quote fell by 0.1% to 143.4.
Some analysts attribute the pair's corrective decline to its current overbought status. Additionally, two pieces of news from Japan have exerted pressure on the dollar/yen pair today.
Firstly, a renewed warning of currency intervention from Tokyo. At the start of the day, Japan's chief currency diplomat Masato Kanda stated that further sharp fluctuations in the yen could compel the government to respond appropriately.
Secondly, the publication of a summary of the BOJ's June meeting. Today's roundup showed that most Japanese officials support the idea of maintaining the current monetary course, including the Yield Curve Control (YCC) mechanism. However, one member of the central bank's board called for a swift adjustment of the yield curve policy.
"At this point, it's better for the regulator to maintain ultra-loose monetary policy, but we should start preparing now for its eventual exit. To prevent consequences from sharp interest rate fluctuations, we need to deal with the YCC as soon as possible," said one participant at the BOJ's June meeting.
Most analysts believe that this opinion should not incite panic or significantly fuel market speculation regarding an imminent change in the yield curve control policy. Nevertheless, it may prompt traders to be on guard ahead of the Bank of Japan's July meeting.
In the near future, investors are likely to closely monitor any comments made by Japanese officials. If any hints towards a potential change in Yield Curve Control (YCC) are detected, it should lend support to the yen against the dollar.
Furthermore, if you factor in investors' growing fears of Japanese government intervention in the market, USD/JPY's upside potential will be limited in the medium term.
Technical analysis
Despite the recent pullback, the USD/JPY pair stays in the focus of buyers. Current buy signals from the MACD inspire hope for the pair's further growth. At the same time, an overbought RSI could hinder its confident rise.
If sellers challenge the bullish channel by breaching the nearest support at 143.20, a 2-week ascending trendline near 142.40 will act as additional support.
Before bears can take the situation entirely under their control, they will have to break through the ascending support line from early May (140.80) and the 200-SMA (139.40).
On the other hand, to maintain the bullish momentum, buyers need to break above the key level of 144, followed by the 8-week-old ascending trendline at 144.30.
After that, the upper line of the ascending channel located near the 144.45 mark may serve as the final defense for bears.
In the event that the asset remains stable after hitting the 144.45 level, it may rise even further to the high of September 2022 at 145.90.