USD/JPY back below 131.50 mark as focus shift to upcoming FOMC meeting

• USD/JPY responding to evolving US Treasury yield dynamics amid banking turmoil.
• Japanese Yen gains ground over US Dollar as a safe haven. 
• Financial crisis reverberation as the Fed navigates uncertain times.  

The USD/JPY closely follows the short end of the US Treasury (UST) yield curve, as diminishing demand for the US Dollar weighs on the pair. This comes amid speculation that the Federal Reserve (Fed) may not pursue aggressive rate hikes as anticipated due to the recent banking turmoil.

On Monday, the US dollar weakened as investors responded to UBS's acquisition of its struggling competitor, Credit Suisse, for CHF 3 billion. Following the global banking crisis, the US Dollar is losing its safe-haven status, while the Japanese Yen has regained its conventional safe-haven status.

The collapse of Silicon Valley Bank and Signature Bank earlier this month sent shockwaves through the markets, causing a plunge in banking stocks and concerns that central bank monetary tightening could lead to a recession.

In response to the ongoing banking crisis, the Fed has opened swap lines to other central banks to provide US Dollar liquidity. This move may contribute to the downward pressure on US Dollar demand.

Investors are cautiously watching the Fed's decision on Wednesday's conclusion of a two-day meeting. Before the banking turmoil, many market participants had expected a 50 basis point (bps) interest rate hike from the Fed at its March meeting. 

However, Fed funds futures now indicate a 28.4% probability of the Fed maintaining its overnight rate at 4.5%-4.75%, and a 71.6% likelihood of a 25 bps increase, according to CME's FedWatch Tool.

Citing some earlier Wall Street Journal (WSJ) reports, the Fed faces a difficult decision, should they continue raising rates to combat persistent high inflation or pause due to the intense banking crisis?

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