Dollar bulls continue to dominate. Yesterday, the American currency once again proved to be stronger than its main competitors. The greenback posted its steepest daily gain against the yen. The USD/JPY pair closed above 137.50. Moreover, it seems this is not the limit. According to experts, the US dollar will extend its rally, hitting new highs.
Dollar's rally
The US dollar is a currency that can get away with anything. To give an example, it is enough to analyze the greenback's behavior over the past few days.
Despite the risk of a US debt default, the dollar gains value. After all, investors are worried that the crisis in the world's largest economy will impact other countries and lead to a global collapse.
On the other hand, if there is no default, there will be no recession. This plays into the hands of the US Federal Reserve, which continues to fight high inflation by tightening monetary conditions in the country.
Anyway, the dollar finds ways to maintain its dominant position. Talks on the US debt ceiling support it regardless of how they are going on.
Yesterday, the DXY index, tracking the relative value of the US dollar against a basket of important world currencies, added more than 0.2%, reaching the 7-week high of 102.86.
The greenback was backed up by positive developments in talks on a rise in the US debt ceiling. Notably, US President Joe Biden hold another meeting with congressional leaders on Tuesday, after which Republican Kevin McCarthy left a very encouraging comment.
The official stated that the long-awaited deal to raise the US debt limit, which is supposed to prevent default, could be reached by the end of the week.
However, the fact that the US will be saved from bankruptcy is not the only good news for the dollar. This week, the greenback has caught a positive wave, which contributes to its confident rally.
First of all, a rise in the greenback can be attributed to strong US economic data. Yes, the market is currently pricing in some signs of a slowdown. However, the overall outlook remains optimistic, which affects market sentiment.
Compared to last week, market expectations regarding the Fed's further monetary policy have noticeably strengthened. Investors are now assessing a 20% probability of another tightening cycle, whereas just a couple of days ago, the chance was almost zero.
Traders have also revised their estimates regarding the pace of interest rate cuts in the US. Previously, they expected a fairly sharp reduction by the end of the year (by 80 basis points), but now they predict a 50-basis-point cut.
In addition, the belief that the Federal Reserve will keep interest rates elevated throughout 2023 is becoming increasingly popular. Hawkish comments from US officials have fueled speculation on this matter.
Several Fed members have made it clear this week that the regulator is unlikely to start easing monetary policy by the end of the year, with some policymakers even anticipating higher interest rates.
Such a firm stance has given investors confidence in the regulator's determination and triggered a rise in US Treasury yields. On Wednesday, the yield on 2-year government bonds and 10-year bonds rose to 4.14% and 3.57% respectively, which fueled a rally in USD/JPY.
On Wednesday, the USD/JPY pair showed the best dynamics among all major currency pairs. The exchange rate soared by almost 0.9%, hitting an intraday high of 137.63.
Weaker yen
With each passing day, the yen loses value as hopes for long-awaited changes from both the Federal Reserve and the Bank of Japan fade away.
If the Federal Reserve does not pause interest rate hikes at its upcoming meeting in June and the Bank of Japan once again declares its commitment to ultra-loose monetary policy, this will lead to another increase in the interest rate differential between the US and Japan.
This scenario will grab the attention of carry traders who will become more active in going short on the Japanese currency. Julius Baer's Head Technical Analyst Mensur Pocinci believes that increased monetary policy divergence will contribute to a recovery in the USD/JPY pair in the medium term.
According to the expert, the pair has every chance of approaching one-year highs if the yen remains weak. However, a return to its October peaks at this stage is unlikely as the dollar's upward cycle should significantly slow down as the default risk diminishes.
Nevertheless, most analysts predict another surge in volatility, which could allow the USD/JPY pair to gain value as early as tomorrow. Data on inflation in Japan for April could serve as a catalyst.
According to economists, Japan's overall inflation is forecast to inch down to 2.5% from 3.2% in March. The core CPI is expected to decline to 3.4% from 3.8%.
If the indicators meet economists' forecasts or show a sharper-than-expected decline, it will finally dispel traders' illusions about a possible shift in the policy stance of the Bank of Japan.
Notably, like his predecessor Haruhiko Kuroda, Japan's new central bank governor Kazuo Ueda has repeatedly stated the need to reach stable and sustainable inflation to take a hawkish stance.
Further signs of easing inflationary pressures in the country may confirm the regulator's view of a temporary nature of price increases. In this case, the normalization of the BOJ's monetary course will be postponed once again.
USD/JPY technical analysis
Yesterday, the USD/JPY pair gained strong upside momentum but faced severe resistance at the one-year high of 137.91. If dollar bulls manage to overcome this area in the near future, the pair will head toward the 139.89 level posted on November 30 and probably the round mark of 140.
Alternatively, if the price fails to break through 138.00, it will most likely pull back to the 137.00 mark. The almost-overbought RSI line currently signals a possible decline in the asset.
