• USD/JPY gained traction for the third straight day and climbed to a fresh two-decade high.
• The divergent Fed-BoJ policy stance remained supportive of the ongoing positive move.
• The risk-off mood could underpin the safe-haven JPY and cap gains, only for the time being.

The USD/JPY pair maintained its bid tone through the early European session and was last seen trading around the 131.15-131.20 region, just a few pips below a fresh two-decade high.

A big divergence in the monetary policy adopted by the Fed and the Bank of Japan turned out to be a key factor that assisted the USD/JPY pair to gain traction for the third successive day on Monday. The markets seem convinced that the Fed would need to take more drastic action to bring inflation under control and have been pricing in a further 200 bps rate hike for the rest of 2022.

The prospects for a more aggressive policy tightening by the Fed remained supportive of elevated US Treasury bond yields. In fact, the yield on the benchmark 10-year US government bond rose to its highest level since November 2018, which assisted the US dollar to stand tall near a 20-year high. This further impressed bullish traders and acted as a tailwind for the USD/JPY pair.

In contrast, the BoJ has promised to conduct unlimited bond purchase operations to defend its “near-zero” target for 10-year yields and vowed to keep its existing ultra-loose policy settings. That said, the prevalent risk-off environment extended some support to the safe-haven Japanese yen and kept a lid on any further gains for the USD/JPY pair, at least for the time being.

Nevertheless, the fundamental backdrop supports prospects for a further near-term appreciating move. Hence, any meaningful dip might still be seen as a buying opportunity and remain limited. Meanwhile, Economists at Nordea expect spot prices to advance towards the 135 level by year-end: “Back in 2002, USD/JPY topped at 135 and we expect USD/JPY to move towards this level by end-2022.”

There isn't any major market-moving economic data due for release from the US, leaving the USD/JPY pair at the mercy of the USD price dynamics/US bond yields. Apart from this, traders will take cues from the broader market risk sentiment to grab short-term opportunities. The focus, however, would remain glued to the release of the latest US consumer inflation figures on Wednesday.

Technical levels to watch