USD/JPY oscillates in a range near 138.00 mark, downside remains cushioned

• USD/JPY edged lower for the third successive day on Tuesday amid subdued USD demand.
• Diminishing odds for a more aggressive Fed rate hike in July continued weighing on the buck.
• The Fed-BoJ policy divergence favours bullish traders and should help limit deeper losses.

The USD/JPY pair remained on the defensive for the third successive day on Tuesday and was seen trading with modest intraday losses, around the 138.00 mark during the early European session.

The US dollar struggled to gain any meaningful traction or capitalize on the overnight bounce from a one-week low amid diminishing odds for a more aggressive policy tightening by the Federal Reserve. In fact, several FOMC members last week pushed back against market bets for a supersized 100 bps rate hike at the upcoming meeting on July 26-27. This, in turn, continued acting as a headwind for the USD and weighed on the USD/JPY pair.

Market participants, however, seem convinced that the recent surge in US consumer inflation, to a four-decade high in June, warrants a larger Fed rate hike move later in the year. The expectations remained supportive of elevated US Treasury bond yields, which offered some support to the greenback. In contrast, the Bank of Japan has repeatedly said that it would stick to the ultra-loose monetary policy and ease further as necessary.

The divergent policy stance adopted by the Fed and the BoJ supports prospects for the emergence of some dip-buying around the USD/JPY pair and an extension of the recent strong bullish run. That said, traders preferred to wait on the sidelines and refrained from placing aggressive bets ahead of the BoJ decision on Thursday. Nevertheless, the fundamental backdrop still seems tilted firmly in favour of bearish traders.

Hence, it would be prudent to wait for strong follow-through selling before confirming that the USD/JPY pair has topped out and positioning for any meaningful corrective decline. Traders now look forward to the US housing market data - Building Permits and Housing Starts. This, along with the broader market risk sentiment and the USD price dynamics, might provide a fresh trading impetus to the USD/JPY pair.

Technical levels to watch