• USD/JPY edges lower on Tuesday, albeit lacks any follow-through selling.
• A softer risk tone underpins the JPY and acts as a headwind for the pair.
• The Fed-BoJ policy divergence lends support and helps limit the downside.

The USD/JPY pair pulls back from a nearly two-month high, around the 137.75-137.80 region touched earlier this Tuesday and remains on the defensive heading into the North American session. The pair is currently placed just below the mid-137.00s, down less than 0.10% for the day, and seems poised to prolong its recent appreciating move.

A softer risk tone drives some haven flows towards the Japanese Yen (JPY) and is seen as a key factor exerting some downward pressure on the USD/JPY pair amid subdued US Dollar (USD) price action. In fact, the USD Index (DXY), which tracks the Greenback against a basket of currencies, struggles to capitalize on its intraday uptick to a two-week high touched on Tuesday. A fresh leg down in the US Treasury bond yields, dragged down by expectations that the Federal Reserve (Fed) will signal a pause in its policy-tightening cycle, acts as a headwind for the buck.

The markets, however, have fully priced in another 25 bps rate hike at the end of the two-day policy meeting on Wednesday. Moreover, the US ISM report released on Monday showed that there was a build-up of inflation pressures last month data kept alive the possibility of a further hike in June and continue to lend support to the Greenback. This marks a big divergence in comparison to the Bank of Japan's (BoJ) dovish stance, which supports prospects for the emergence of some dip-buying around the USD/JPY pair and should help limit the downside.

Even from a technical perspective, the overnight sustained move and close above the very important 200-day Simple Moving Average (SMA) add credence to the near-term positive outlook. Bullish traders, however, might refrain from placing aggressive bets ahead of the highly-anticipated FOMC monetary policy decision on Wednesday. The focus will then shift to the release of the closely-watched US monthly employment details, popularly known as the NFP report on Friday, which should help determine the near-term trajectory for the USD/JPY pair.

Technical levels to watch