USD/JPY trades with modest losses below mid-140.00s, downside seems limited

• USD/JPY retreats from a fresh YTD peak touched this Tuesday amid a modest USD downtick.
• The Fed-BoJ policy divergence and the US debt ceiling optimism act as a tailwind for the pair.
• The fundamental backdrop still supports prospects for a further near-term appreciating move.

The USD/JPY pair pulls back from a six-month high touched earlier this Tuesday and turns lower for the second successive day. Spot prices slide below the mid-140.00s during the first half of the European session, though any meaningful corrective pullback still seems elusive.

The US Dollar (USD) bulls opt to take some profits off the table following the recent runup to over a two-month high amid retreating US Treasury bond yields. This, along with a slightly overbought Relative Strength Index (RSI) on the daily chart, prompts some long-unwinding trade around the USD/JPY pair. The USD downside, however, remains cushioned amid expectations that the Federal Reserve (Fed) will keep interest rates higher for longer.

In fact, the current market pricing indicates a greater chance of another 25 bps lift-off at the next FOMC monetary policy meeting in June. The bets were reaffirmed by the recent hawkish remarks by a slew of influential Fed officials and the US Core PCE Price Index released on Friday, which pointed to sticky inflation. This should act as a tailwind for the USD and supports prospects for the emergence of some dip-buying around the USD/JPY pair.

The Bank of Japan Governor Kazuo Ueda, meanwhile, had said that the central bank will continue easing with yield curve control. Adding to this, the Tokyo CPI released last Friday showed that inflation in Japan’s capital city eased more than expected in May. This validates the BoJ's view that inflation in Japan is likely to slow back below the 2% target in the middle of the current fiscal year and allow the central bank to stick to its dovish stance.

This, along with a positive risk tone, could undermine the safe-haven Japanese Yen (JPY) and contribute to limiting losses for the USD/JPY pair. US lawmakers signalled that they have reached a tentative agreement to suspend the US government's $31.4 trillion debt ceiling till January 25 and avert an unprecedented default by the world's largest economy. This, in turn, boosts investors' confidence, which is evident from the upbeat mood around the equity markets and is seen driving flows away from traditional safe-haven assets, including the JPY.

The aforementioned fundamental backdrop suggests that the path of least resistance for the USD/JPY pair is to the upside. Hence, any meaningful pullback might still be seen as a buying opportunity and is more likely to remain cushioned. Traders now look to the Conference Board's US Consumer Confidence Index for short-term opportunities later during the early North American session.

Technical levels to watch