USD/JPY inter-markets: runs the risk of a sharp reversal if risk sentiment deteriorates

After staging a remarkable recovery of nearly 750-pips from sub-100.00 level, recovering all of the Brexit-led sharp losses, the USD/JPY pair has now entered a near-term consolidation phase around 106.00 handle. 

Last week, the pair jumped to its highest level since June 7 as expectations of additional fiscal stimulus measures from the Japanese government forced traders to unwind their bearish bets. Moreover, global risk-on sentiment is also denting the safe-haven appeal of the Japanese currency and providing additional boost to the major. A sharp slide in the Volatility Index (VIX) is reflective of improving investor risk appetite. 

Adding to this, the incoming US economic data continues to fuel expectations of an imminent Fed rate-hike, later during 2016, with CME group's Fed Fund rate futures pointing to around 40% probability of such an action in December. Meanwhile, increasing yield differential between US and Japanese 10-year treasuries was also seen supportive for the pair's up-surge in the past couple of weeks.

The pair, however, seems to have lost is upside momentum as risk-aversion looks to make a come-back, as depicted by an up-tick in VIX and dip in treasury yields. Moreover, traders also seem to position themselves cautiously ahead of this week's key event risks, namely - FOMC and BOJ monetary policy meetings on Wednesday and Friday respectively. 

The Fed is not expected to change its current monetary policy stance, while market remains divided over the prospects of additional monetary easing by BOJ. Hence, any negative surprise, especially from BOJ, would seriously deteriorate global risk appetite and trigger a fresh bout of volatility across global financial markets, which would eventually boost the safe-haven appeal of the Yen and drag the USD/JPY pair sharply lower.

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