USD/JPY bounces off lows, back around mid-113.00s

The USD/JPY pair reversed an intraday dip and climbed back above mid-113.00s, closer to the top end of its daily trading range during the early European session.

The pair attracted some dip-buying on Wednesday and recovered over 25 pips from the daily swing lows, around the 113.35 region, though lacked any strong follow-through. The recent widening of the US-Japanese government bond yield differential was seen as a key factor that drove flows away from the Japanese yen and extended some support to the USD/JPY pair.

The US bond yields have been rallying since late September when the Fed signalled that it would begin tapering its bond purchases by the end of 2021. In fact, the yield on the benchmark 10-year US government bond shot to four-month tops on Friday. On the other hand, the Bank of Japan's yield curve control policy held the yield on the 10-year Japanese government bond near zero.

The markets might have also started pricing in the possibility of an interest rate hike in 2022 to counter the risk of inflation becoming too high. This was seen as another factor that pushed the bond yields higher. That said, a modest US dollar weakness kept a lid on any further gains for the USD/JPY pair amid a softer risk tone, which tends to benefit the safe-haven JPY.

Worries that a widespread rally in commodity prices will stoke inflation and signs of a global economic slowdown have been fueling speculations about the return of stagflation. Apart from this, fears about a spillover from China Evergrand's debt crisis weighed on investors sentiment. This was evident from the prevalent caution mood around the global equity markets.

Apart from this, overbought conditions on short-term charts might further hold bullish traders from placing aggressive bets around the USD/JPY pair. Investors now await the release of the US consumer inflation figures and the FOMC monetary policy meeting minutes to gauge the Fed's path on normalizing monetary policy.

This will play a key role in influencing the near-term USD price dynamics. This, along with the broader market risk sentiment, should determine the next leg of a directional move for the major.

Technical levels to watch