USD/JPY remains on the defensive amid weaker USD, downside seems cushioned

• USD/JPY witnessed modest intraday pullback from the vicinity of over a two-decade high.
• The recent pullback in the US bond yields undermined the USD and exerted some pressure.
• The Fed-BoJ policy divergence should limit losses and warrants caution for bearish traders.

The USD/JPY pair attracted some sellers near the 135.45 region on Monday and retreated over 90 pips from the vicinity of a 24-year peak touched last week. Spot prices dropped to a daily low, around mid-134.00s during the early European session and eroded a part of Friday's dovish Bank of Japan-inspired strong gains.

The recent sharp pullback in the US Treasury bond yields failed to assist the US dollar to capitalize on the previous day's move up and held back bulls from placing fresh bets around the USD/JPY pair. Apart from this, the intraday downtick lacked any obvious fundamental catalyst and is more likely to remain limited amid the widening Japan-US interest rate differential.

The Bank of Japan (BoJ) on Friday decided to leave its ultra-easy monetary policy settings unchanged and reiterated its guidance to keep borrowing costs at "present or lower" levels. The BoJ also pledged to guide the 10-year yield to around 0%. In contrast, the Fed last week delivered the biggest hike since 1994 and indicated a faster policy tightening path to tame surging inflation.

Moreover, the Fed's so-called dot plot showed that the median year-end projection for the federal funds rate moved up to 3.4% from 1.9% in the March estimate and 3.8% in 2023. This should act as a tailwind for the US bond yields and favours the USD bulls, warranting caution before positioning for deeper losses amid lighter trading volumes on the back of a holiday in the US.

That said, a scheduled speech by St. Louis Fed President James Bullard might influence the USD price dynamics and provide some impetus later during the early North American session. Nevertheless, the fundamental backdrop supports prospects for the emergence of some dip-buying around the USD/JPY pair.

Technical levels to watch