USD/JPY corrects from multi-year top, eyes mid-120.00s amid reviving safe-haven demand

The USD/JPY pair surrendered its intraday gains to a fresh multi-year peak and retreated to the daily low, around the 120.70-120.65 region during the early North American session.

The pair prolonged its recent strong bullish trajectory witnessed over the past three weeks or so and gained strong follow-through traction during the first half of the trading on Wednesday. The momentum pushed the USD/JPY pair to the highest level since February 2016, though lost steam near the 121.40 region amid reviving safe-haven demand.

The market sentiment remain fragile amid the lack of progress in the Russia-Ukraine peace negotiations. Italy's Prime Minister Mario Draghi noted that Russia is not showing interest in a truce for successful peace talks. Separately, Russian Foreign Minister Sergei Lavrov said that talks with Ukraine are difficult as Kyiv is constantly changing its position.

The incoming geopolitical headlines tempered investors' appetite for perceived riskier assets. This was evident from modest intraday pullback in the equity markets, which drove some haven flows towards the Japanese yen and acted as a headwind for the USD/JPY pair. This, in turn, prompted some profit-taking amid extremely overbought conditions on short-term charts.

The downside, however, remains cushioned amid the divergence in the monetary policy stance adopted by the Fed and the Bank of Japan. The Fed indicated last week that it could raise rates at all the six remaining meetings in 2022. Moreover, Fed Chair Jerome Powell suggested that the US central bank could adopt a more aggressive policy to combat stubbornly high inflation.

The markets already seem to have started pricing in the possibility of a 50 bps rate hike at the next FOMC meeting and pushed the yield on the benchmark 10-year US government bond to the highest level since 2019. Conversely, the Japanese 10-year remained anchored below the BoJ's 0.25% ceiling amid the BoJ's ultra-loose policy announced on the last day of the week gone by.

The resultant widening of the US-Japanese bond yield spread should continue to lend support to the USD/JPY pair, warranting some caution before confirming a near-term top. In the absence of any relevant economic data, traders will take cues from developments surrounding the Russia-Ukraine saga. This, along with the US bond yields should produce some opportunities.

Technical levels to watch