USD/JPY eases from two-decade high, downside seems limited amid Fed-BoJ policy divergence

• USD/JPY rallied to the highest level since May 2002 during the early part of trading on Wednesday.
• The divergent Fed-BoJ monetary policy stance weighed heavily on the JPY and acted as a tailwind.
• Overbought conditions on intraday charts capped the upside amid concerns over the Ukraine crisis.

The USD/JPY pair retreated over 50 pips from a two-decade high touched earlier this Wednesday and was last seen trading below the 126.00 mark, still up nearly 0.40% for the day.

The Japanese yen weakened across the board and plunged to its lowest level since May 2002 against the US dollar amid the widening policy divergence between the Bank of Japan and the Fed. In fact, the BoJ Governor Haruhiko Kuroda stressed the need to maintain the current powerful monetary easing to support an economy that is yet to recover to pre-pandemic levels.

On the other hand, Fed Governor Lael Brainard's comments on Tuesday reaffirmed market bets that the Fed will tighten its monetary policy at a faster pace to curb soaring inflation. In an interview with the Wall Street Journal, Brainard emphasized that the central bank will proceed with a series of interest rate hikes, as well as an effort to trim its balance sheet.

This, in turn, assisted the USD/JPY pair to catch aggressive bids on Wednesday and surge past the 125.75-85 resistance zone (YTD/June 2015 high). The momentum pushed the USD/JPY pair beyond the 126.00 mark, though overbought RSI on the intraday charts kept a lid on any further gains amid fading hopes for a diplomatic solution to end the war in Ukraine.

In the latest developments, Russian President Vladimir Putin said on Tuesday that talks with Ukraine are at a dead-end. Putin further added that Ukraine has deviated from the agreements achieved at talks in Istanbul. Nevertheless, the fundamental backdrop seems tilted in favour of bullish traders and supports prospects for an extension of the recent strong move up.

Market participants now look forward to the US economic docket, featuring the release of the Producer Price Index during the early North American session. This, along with the US bond yields, will influence the USD price dynamics and provide a fresh impetus to the USD/JPY pair. Traders will further take cues from the broader risk sentiment to grab some short-term opportunities.

Technical levels to watch