USD/JPY falls to one-week lows below 128.00

• A combination of factors drags USD/JPY lower for the second day in a row on Thursday.
• Recession fears continue to weigh on investor sentiment and boost the yen as a safe haven.
• The pullback in US bond yields causes some selling around the dollar and further contributes to the pair’s decline.
• The divergence in monetary policies between the Fed and the Bank of Japan warrants some caution before opening aggressive bearish positions.

The pair USD/JPY has weakened further below the 128.00 level during the first half of the European session on Thursday and has fallen to a one-week low in the last hour. At time of writing, the pair is trading at 127.75, down 0.35% on the day.

The pair had a hard time capitalizing on its initial positive move and was met with fresh selling near the 129.00 round level, turning lower for the second day in a row on Thursday. The feeling of Prevailing risk aversion fueled safe-haven demand for the Japanese yenwhich, coupled with fresh selling around the US dollar, put downward pressure on the USD/JPY pair.

The markets now seem concerned that more aggressive action by major central banks to curb inflation could affect global economic growth. In addition, the prolonged COVID-19 lockdown in China and the war between Russia and Ukraine have fueled the recession fears. This, in turn, dented risk sentiment and forced investors to retreat to traditional safe-haven assets such as the yen.

The anti-risk flow triggered a modest pullback in US Treasury bond yields, causing some selling around the US dollar and further contributed to the selling tone surrounding the USD/JPY pair. With the latest move lower, USD/JPY has returned to close to the monthly low, around 127.50 touched last week, although the monetary policy divergence between the Fed and the Bank of Japan should act as a tailwind for the pair.

The Fed is expected to maintain its tight monetary policy and raise interest rates by at least 50 basis points in the next two meetings.. Expectations were bolstered by comments from Fed Chairman Jerome Powell on Tuesday in which he stated that he will support interest rate hikes until prices start to fall back to a healthy level. This should limit the decline in US bond yields and the dollar.

Conversely, the Bank of Japan has promised to maintain its current ultra-loose policy setting and has promised unlimited bond-buying to defend its “near-zero” target for 10-year yields. Therefore, it will be prudent to wait for some follow-up selling below the 127.50 area before confirming a further bearish breakout and positioning for any further moves lower.

Market participants now await the US economic calendar, with the release of the Philadelphia Fed Manufacturing Index, the usual weekly initial jobless claims and Existing Home Sales data. Also, US bond yields will weigh on the dollar and give the USD/JPY pair some momentum. Investors will also benchmark the broader market risk sentiment to take advantage of short-term opportunities.