USD/JPY slides back below mid-121.00s, fresh daily low amid retreating US bond yields

• A combination of factors dragged USD/JPY lower for the third successive day on Thursday.
• Fading hopes for diplomacy in Ukraine benefitted the JPY and exerted downward pressure.
• Retreating US bond yields kept the USD bulls on the defensive and contributed to the slide.

The USD/JPY pair edged lower through the early European session and dropped to a fresh daily low, below mid-121.00s in the last hour.

The pair struggled to capitalize on its modest intraday uptick, instead met with a fresh supply in the vicinity of mid-122.00s on Thursday and turned lower for the third successive day. Speculation that officials were uncomfortable and would respond to the Japanese yen's recent weakness turned out to be a key factor that acted as a headwind for the USD/JPY pair.

Moreover, the incoming geopolitical headlines dashed hopes for a diplomatic solution to end the war in Ukraine and further benefitted the safe-haven Japanese yen. Bearish traders further took cues from the ongoing decline in the US Treasury bond yields, which undermined the US dollar and exerted downward pressure on the USD/JPY pair, though the downtick remains cushioned.

The markets seem convinced that the Fed would tighten its monetary policy at a faster pace and deliver a 50 bps rate hike at the next two policy meetings to combat high inflation. Conversely, the Bank of Japan is expected to stick to its ultra-loose policy for a prolonged period. This, in turn, supports prospects for the emergence of some dip-buying around the USD/JPY pair.

The fundamental backdrop makes it prudent to wait for strong follow-through selling below the weekly low, around the 121.20-121.15 region before confirming that the USD/JPY pair has topped out. This would set the stage for an extension of the sharp pullback from levels just above the 125.00 psychological mark, or the highest level since August 2015 touched earlier this week.

Market participants now look forward to the US economic docket, highlighting the release of the Core PCE Price Index - the Fed's preferred inflation gauge. The focus, however, will remain on fresh developments surrounding the Russia-Ukraine saga. The incoming geopolitical headlines would influence the broader market risk sentiment and provide some impetus to the USD/JPY pair.

Technical levels to watch