USD/JPY holds above 127.00 amid risk-on, softer USD continues to cap the upside

• The risk-on mood undermined the safe-haven JPY and extended support to USD/JPY on Monday.
• The prevalent selling bias around the USD held back bulls from placing fresh bets and capped gains.
• Expectations that the Fed would pause the rate hike cycle later this year weighed on the greenback.

The USD/JPY pair gained some positive traction on Monday and held on to its modest intraday gains through the first half of the European session. The pair was last seen trading around the 127.25-127.30 area, up 0.15% for the day.

Investors turned optimistic amid hopes that the easing of COVID-19 restrictions in China would boost the global economy, which was evident from the ongoing risk-on rally in the equity markets. This, in turn, undermined demand for the safe-haven Japanese yen and acted as a tailwind for the USD/JPY pair, though the prevalent US dollar selling bias kept a lid on any meaningful gains.

The markets now expect that the Fed could pause the rate hike cycle after two 50 bps hikes each in June and July. The bets were reaffirmed by Friday's release of the US Personal Consumption Expenditure (PCE) data for April, which suggested that inflationary pressures in the US could be easing. This was seen as a key factor behind the recent slump in the US Treasury bond yields to a multi-week low.

Hence, it will be prudent to wait for strong follow-through buying before positioning for any further upside amid relatively lighter trading volumes on the back of the Memorial Day holiday in the US. Investors might also prefer to wait on the sidelines ahead of this week's important US macro releases scheduled at the beginning of a new month, including the closely watched NFP report on Friday.

In the meantime, the broader market risk sentiment might continue to play a key role in driving haven flows and influencing the JPY. Traders will further take cues from the USD price dynamics to grab short-term opportunities around the USD/JPY pair.

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