USD/JPY corrects further from two-decade high, heavily offered below 128.00 mark

• USD/JPY retreated sharply from a fresh 20-year peak touched earlier this Wednesday.
• Speculation that officials will intervene to curb the JPY slump prompted long-unwinding.
• The Fed-BoJ policy divergence should act as a tailwind and help limit any further losses.

The USD/JPY pair continued losing ground through the mid-European session and plunged to a fresh daily low, around the 127.60 region in the last hour, albeit recovered a few pips thereafter.

The pair witnessed an intraday turnaround from a fresh 20-year high touched earlier this Wednesday and has now retreated around 180 pips from the 129.40 region. Speculation that officials were uncomfortable and would respond to the Japanese yen's recent slump prompted traders to take some profits off the table following the recent parabolic rise in the USD/JPY pair.

In fact, Japanese Finance Minister Shunichi Suzuki made the most explicit warning yet on Tuesday that the damage to the economy from a weakening yen at present is greater than the benefits from it. Adding to this, Bank of Japan Governor Haruhiko Kuroda, who is usually a firm advocate of a weaker currency, also acknowledged that a sharp yen decline could hurt the economy.

Bearish traders further took cues from modest pullback in the US Treasury bond yields, which trigger a US dollar corrective slide from its highest level since March 2020. Despite the negative factors, the downside seems cushioned amid policy divergence between the Fed and the Bank of Japan, which again intervened in the market to check the rise in Japanese 10-year yields.

The BoJ offered to buy unlimited amounts of Japanese government bonds on Wednesday to defend the 0.25% yield cap. Moreover, the BoJ has repeatedly said that it remains ready to use powerful tools to avoid long-term interest rates from rising too much and sustain the current powerful monetary easing to support economic recovery.

On the other hand, the US central bank is determined to keep a lid on soaring inflation and tighten its monetary policy at a faster pace. The markets have been pricing in multiple 50 bps rate hikes and the bets were reaffirmed by influential FOMC members - St. Louis President James Bullard, Chicago Fed President Charles Evans and Minneapolis Fed President Neel Kashkari.

The fundamental backdrop favours the USD bulls and supports prospects for the emergence of some dip-buying at lower levels. Hence, it will be prudent to wait for strong follow-through selling before confirming that the USD/JPY pair has topped out in the near term and positioning for any meaningful corrective slide.

Technical levels to watch