USD/JPY subdued to the south of 115.00 level as Monday’s risk-on momentum fades

• USD/JPY is trading subdued just to the south of the 115.00 level after Monday’s surge above 114.50.
• A sychronised rally in risk assets on Monday weighed on the yen at the time.
• For USD/JPY to test annual highs at 115.50, longer-term US yields will likely need to recover some more.

USD/JPY is trading in subdued fashion this Tuesday underneath, but not far from, the 115.00 level after Monday’s risk-on fuelled surge that pushed it back to the north of the 114.50 level. The pair has eased back from Asia Pacific session highs in the mid-114.90s, but found decent support at 114.70 and is now trading in the 114.80s. FX market conditions are unusually subdued this Tuesday due to market closures in various parts of the world and generally thinned liquidity/volumes with many European and North American-based market participants away for ongoing Christmas and New Year’s celebrations.

Fuelling Monday’s rally from 114.30ish lows to session highs around 114.90 was a surge in US (and global) equities, as well as in crude oil and other commodity prices. Traders are feeling much more positive about the rapid spread of the highly transmissible Omicron Covid-19 variant across the globe as governments in Europe (UK, France, Spain) refrain, for now, from toughening Covid curbs with hospitalisation rates yet to rise. That has raised hopes that the variant will prove less disruptive than feared for the US (and global) economy over the coming months.

The surge in risk-on sentiment unsurprisingly hit demand for the safe-haven yen, which underperformed across the board at the time versus its G10 counterparts. But USD/JPY seems reluctant to push above 115.00 and on towards a test of its November highs at 115.50. That is because, despite the recent surge in stocks and other risk-sensitive assets, longer-term US bond yields are yet to join the party and start rising. The US 10-year yield on Tuesday continues to trade subdued underneath the 1.50% mark, leaving it still about 20bps below pre-Omicron levels. USD/JPY is highly correlated to the US 10-year yield, and so for the pair to test its annual highs around 115.50, the 10-year will likely need to rally, which seems unlikely to happen before 2022 with bond markets in holiday mode.