USD/JPY keeps the red below mid-138.00s, downside potential seems limited

• USD/JPY meets with some supply on Tuesday and erodes a part of the overnight strong gains.
• Retreating US bond yields weigh on the USD and exert some downward pressure on the major.
• The risk-on impulse, Fed-BoJ policy divergence could undermine the JPY and help limit losses.

The USD/JPY pair edges lower on Tuesday and for now, seems to have snapped a two-day winning streak to its highest level since mid-July, around the 139.00 mark touched the previous day. The pair remains on the defensive through the first half of the European session and is currently hovering around the 138.30-138.25 area, just a few pips above the daily high.

The US dollar drifts lower for the second straight day and turns out to be a key factor exerting some downward pressure on the USD/JPY pair. The ongoing USD profit-taking slide from a 20-year high touched the previous day could be solely attributed to a further decline in the US Treasury bond yields. This, in turn, results in the narrowing of the US-Japan yield differential, which benefits the safe-haven Japanese yen and further contributes to the offered tone surrounding the major.

That said, the risk-on impulse, along with a big divergence in the monetary policy stance adopted by the Bank of Japan and the Federal Reserve, should cap gains for the safe-haven JPY. In fact, the Bank of Japan Governor Haruhiko Kuroda reiterated on Monday that the central bank will stick to its easing policy stance until wages and prices rise in a stable and sustainable manner. In contrast, the Fed is expected to deliver another supersized 75 bps rate hike at its September policy meeting.

The prospects for a more aggressive policy tightening by the Fed were reaffirmed by Fed Chair Jerome Powell's hawkish remarks on Friday. During his speech at the Jackson Hole Symposium, Powell signalled that interest rates would be kept higher for longer to bring down inflation. This, in turn, suggests the path of least resistance for the USD/JPY pair. Hence, any subsequent downtick might still be seen as an opportunity for bullish traders and is more likely to remain limited.

Market participants look forward to the US economic docket - featuring JOLTS Job Openings data and the Conference Board's Consumer Confidence Index later during the early North American session. This, along with the US bond yields, might influence the USD. Apart from this, the broader risk sentiment might contribute to producing short-term trading opportunities around the USD/JPY pair.

Technical levels to watch