The USD/JPY pair continues to recover from a sharp decline last week. This morning, the pair managed to break above the 139 level, rising by 0.4% at the time of publication. Let's explore what fueled the upward movement and why some experts believe that USD has a chance to return to its recent highs.
Sweetening the pill for USD
The US currency remains under strong pressure from market speculations regarding the imminent end of the current tightening cycle in the US. Most investors expect the Federal Reserve to resume the interrupted series of interest rate hikes next week. However, the majority thinks that there will be no more rate hikes this year.
Bearish sentiments in the market significantly increased last week when the market received cooler-than-expected data on US consumer inflation and producer price growth.
The deflationary shock led to the largest weekly decline in the greenback since November 2022. Over the past five sessions, the US dollar index dropped more than 2% against a basket of major currencies.
During this period, the worst performer was the USD/JPY pair. Over the past seven days, its exchange rate plummeted by almost 3%, hitting a new 2-month low of 137.2 last Friday.
This week, USD managed to win back some of its early losses against the Japanese yen. Yesterday, the dollar/yen pair rose by 0.1% during the day, closing at 138.8. This morning, it continued its ascent, breaking through the key threshold of 139.
The growth driver for the greenback was the retail sales report in the US. Despite one of the crucial indicators of the US economy growing worse than expected in June (0.2% versus the anticipated 0.5%), consumer spending remained stable.
"More moderate than anticipated data indicates that the Fed has already made some progress in its fight against inflation. However, we still received quite robust statistics, which could positively impact GDP and domestic demand. This suggests that the Fed has solid grounds to raise rates in July," noted CIBC Capital Markets analyst Bipan Rai.
If the American regulator raises rates next week and hints at the potential for further tightening, it will help the dollar recover in all directions, including against the yen.
In a recent report, analysts from The Bank of America drew attention to the current oversold condition of the USD/JPY pair. They noted that the recent surge in the Japanese currency significantly exceeded expected fluctuations, but the dust should settle soon and the yen will return to its recent lows.
JPY nurturing false hopes
The sharp jump in the Japanese currency against the dollar last week was also triggered by the rise in speculation about the BOJ's yield curve control policy change at the upcoming meeting.
Talks on this topic gained momentum in the market after the recent publication of May's wage statistics in Japan.
Significant positive shifts in wage growth reinforced the belief that inflation in Japan will continue to strengthen and may soon become more stable.
The BOJ has repeatedly stated that sustainable price growth is a key condition for the regulator to shift to hawkish policies. Yesterday, the head of the BOJ once again emphasized this at a press conference after the G20 meeting in India.
Speaking at a press conference after the G20 meeting in India, Kazuo Ueda stressed that the BOJ would maintain its dovish stance as Japan is still far from reaching its 2% inflation target.
Discussing the need for YCC correction at the July meeting, BOJ Governor Kazuo Ueda said that it would not be appropriate to change the current policy until the condition of achieving stable inflation at 2% is met.
Ueda's dovish comment put significant pressure on the yen, which helped the USD/JPY pair to form an upward correction.
The next potential trigger for the dollar/yen pair will be the inflation data in Japan on Friday. Stronger statistics may increase market speculation about upcoming changes in BOJ's monetary policy, which will boost the yield of 10-year government bonds and trigger another wave of yen strengthening.
On the contrary, moderate price growth in Japan will convince market participants that it is not yet time for changes. In that case, the yen may continue its current decline against the dollar.
"We expect that June's data on the Consumer Price Index in Japan will indicate that inflation has reached its peak. This will likely reinforce traders' belief that the Bank of Japan will not make any YCC adjustments at its meeting on July 27-28," noted Bloomberg Economics analyst Taro Kimura.
If the Japanese regulator does not make any changes to its current policy this month, it could deliver a massive blow to the yen. Some experts predict that such a development will lead to the USD/JPY pair rising above 140.
Technical outlook
To develop bullish momentum, buyers of the dollar/yen pair need to overcome strong resistance near the upper boundary of the ascending trend channel, currently located around 139.70.
The next important barrier for them will be the 200-day SMA, followed by the psychological level of 140.00. A decisive breakout of this level will prompt traders to close short positions. As a result, bears will lose ground while bulls will accelerate their rise towards the intermediate range of 140.45-140.50 on the way to 141.00 and the selling zone at 141.25-141.300.
On the other hand, sustained weakness of the pair below the 139.00 mark may attract buyers. If the price drops below the weekly low in the 137.70-137.65 area reached yesterday, it will confirm the breakout of the bearish flag and reveal the merging of the 100-day and 200-day SMAs near the 137.00 level. In that case, the pair will continue its steep decline from last week.