USD/JPY rebounds from 138.00/nearly two-month low, upside potential seems limited

• USD/JPY attracts some buying on Thursday and stalls its recent pullback from the YTD peak.
• A positive risk tone undermines the JPY and prompts short-covering amid oversold conditions.
• Bearish USD might cap any meaningful recovery amid expectations for a shift in BoJ's stance.

The USD/JPY pair stages a modest bounce from the 138.00 neighbourhood, or a nearly two-month low touched during the Asian session on Thursday and hits a fresh daily high in the last hour. Spot prices currently trade around the 138.60 region, up less than 0.10% for the day, and for now, seem to have stalled the recent sharp retracement slide from the YTD peak touched on June 30.

The prevalent risk-on environment - as depicted by an extended rally in the equity markets - undermines the safe-haven Japanese Yen (JPY). This, along with oversold conditions on hourly charts, prompts some intraday short-covering around the USD/JPY pair, especially after a steep decline of around 700 pips witnessed over the past two weeks or so from levels just above the 145.00 psychological mark. That said, any meaningful recovery still seems elusive on the back of the underlying bearish sentiment surrounding the US Dollar (USD).

In fact, the USD Index (DXY), which tracks the Greenback against a basket of currencies, languishes near its lowest level since April 2022 as investors now seem convinced that the Federal Reserve (Fed) will hike interest rates only one more time this year. The bets were reaffirmed by the US CPI report on Wednesday, showing that consumer prices moderated further in June. This leads to a further decline in the US Treasury bond yields, which should continue to weigh on the USD and keep a lid on any meaningful upside for the USD/JPY pair.

Apart from this, speculations that the Bank of Japan (BOJ) will adjust its ultra-loose policy settings as soon as this month could lend support to the JPY and contribute to capping gains for the USD/JPY pair. This, in turn, warrants some caution for bullish traders and makes it prudent to wait for strong follow-through buying before confirming that spot prices have formed a near-term bottom. Traders now look to the US economic docket, featuring the Producer Price Index (PPI) and the Weekly Initial Jobless Claims, for short-term opportunities.

Technical levels to watch