USD/JPY stands tall near 20-year high, just below mid-128.00s

• The Fed-BoJ policy divergence pushed USD/JPY to a fresh 20-year high on Tuesday.
• Extremely overbought conditions warrant caution before placing fresh bullish bets.
• Investors now eye US housing market data, Fedspeak for some trading opportunities.

The USD/JPY pair maintained its strong bid tone through the first half of the European session and was last seen trading just a few pips below the mid-128.00s, or the highest level in nearly a two-decades.

A combination of factors assisted the USD/JPY pair to prolong its strong bullish trajectory and gain strong follow-through traction for the 13th successive day on Tuesday. A big divergence in the monetary policy stance adopted by the Bank of Japan and the Fed was seen as a key factor behind the recent surge witnessed since the beginning of this month.

The BoJ has been intervening to keep the yield on Japanese 10-year government bonds below 0.25% and repeatedly said to retain its ultra-loose monetary policy. Conversely, the yield on the benchmark 10-year US government bond surged to its highest level since December 2018 amid expectations that the Fed would tighten its monetary policy at a faster pace.

In fact, the markets have been pricing in multiple 50 bps rate hikes by the Fed in the wake of worries that the worsening Ukraine crisis would put upward pressure on already high inflation. This continued to provide support to the US dollar, which provided an additional boost to the USD/JPY pair and remained supportive of the ongoing positive move.

The momentum could further be attributed to some technical buying following the overnight sustained move above the 127.00 round figure. The subsequent strength took along some short-term trading stops placed near the 128.00 mark, setting the stage for additional gains. That said, a combination of factors might hold back bulls from placing fresh bets.

The prospects for a more aggressive Fed response to combat stubbornly high inflation, along with a protracted Russia-Ukraine war, continued weighing on investors' sentiment. This was evident from a softer tone around the equity markets, which tends to benefit the safe-haven JPY. This, in turn, could cap the USD/JPY pair amid extremely overbought conditions.

Market participants now look forward to the US housing market data and a scheduled speech by Chicago Fed President Charles, due later during the early North American session. Apart from this, the US bond yields will influence the USD and provide some 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