USD/JPY flirts with daily low, below mid-138.00s amid the global flight to safety

• USD/JPY meets with a fresh supply on Monday amid reviving demand for the safe-haven JPY.
• The narrowing of the US-Japan rate differential also underpins the JPY and weighs on the pair.
• A modest USD strength could offer some support to the major and help limit any further losses.

The USD/JPY pair struggles to capitalize on Friday's modest bounce and comes under some renewed selling pressure on the first day of a new week. The pair maintains its offered tone through the early European session and is currently flirting with the daily low, around the 138.30-138.25 region.

The worsening COVID-19 situation drives haven flows towards the Japanese Yen, which is seen exerting downward pressure on the USD/JPY pair. In fact, China reported a record-high number of daily infections on Saturday, forcing the government to impose strict anti-COVID measures in several cities. Moreover, public discontent over the zero-COVID policy flared protests across China and raises concerns about a further slowdown in economic activity. This, in turn, keeps investors on the edge and boosts demand for traditional safe-haven assets.

The flight to safety, along with growing acceptance of a less aggressive policy tightening by the Fed, continue to drag the US Treasury bond yields lower. This results in the further narrowing of the US-Japan rate differential, which provides an additional lift to the Japanese Yen. That said, a modest US Dollar strength extends some support to the USD/JPY pair. This, along with a big divergence in the monetary policy stance adopted by the Federal Reserve and the Bank of Japan, could help limit any further losses, at least for the time being.

Despite a dovish assessment of the November FOMC meeting minutes, the US central bank is still expected to deliver another 50 bps rate hike in December. In contrast, BoJ, so far, has shown no inclination to hike interest rates. Moreover, BoJ Governor Haruhiko Kuroda reiterated that the central bank will stick to its monetary easing to support the economy and achieve the 2% inflation target in a stable fashion. In the absence of any relevant economic data, this warrants caution before placing fresh bearish bets around the USD/JPY pair.

Technical levels to watch