USD/JPY Forecast: Three reasons why pair could set new yearly highs above 113.00

The USD/JPY pair hit two-month highs a few minutes before press time and could soon hit new yearly highs above 113.18, as the yield differential and technical studies are aligned in favor of the bulls. Further, the pair's resilience to risk aversion could be considered a positive sign.

As of writing, the pair is trading at 112.86, having hit a low of 112.74 earlier today.

JPY ignores risk-off

The Dow Jones Industrial Average (DJIA) backed off from Friday's record highs as stocks, particularly vulnerable to tariffs, posted losses yesterday. The blue-chip index fell 181.45 points, or 0.7%, to 26562.05 yesterday, posting its biggest one-day percentage decline since August. The Euro Stoxx 600 also slipped 0.6 percent Monday on trade tensions.

Still, the USD/JPY pair rose more than 30 pips yesterday, signaling the bullish sentiment is quite strong.

Charts are biased toward the USD bulls

The spot looks set to test 113.40 (target as per the measured height method) in a day or two, having witnessed a bull flag breakout on the hourly chart. Further, a series of higher highs and higher lows, ascending 50-hour, 100-hour and 200-hour moving averages indicate the path of least resistance is on the higher side.

Yield differential continues to widen in a USD-positive manner

At press time, the two-year US-Japan yield spread is seen at a fresh 11-year high of 294 basis points. Further, the 10-year yield spread, which is more sensitive to risk sentiment in the market, is seen at 296 basis points - the highest level since May 22.

More importantly, the yield differentials could widen further in a USD-positive manner as the Bank of Japan (BOJ) July meeting minutes released earlier today sounded more dovish than hawkish. Indeed, the tweak policy introduced at the end of July boosted hawkish expectations, however, the minutes reiterated that such expectations are premature and the wider JGB trading band was introduced to make ultra-easy bias more sustainable.

Meanwhile, the Fed is seen raising rates by 25 basis points tomorrow and will likely deliver another rate hike in December. Also, rising oil prices could force the Fed to signal a low tolerance for above-target (2 percent) inflation.

All-in-all, the odds of the pair setting a new yearly high above 113.18 in the next day or two are high.