Japanese Yen drifts lower ahead of Japan's parliamentary vote for new PM

• The Japanese Yen remains on the defensive amid delayed BoJ rate hike bets.

• Dovish Fed expectations could undermine the USD and cap the USD/JPY pair.

• Traders might also opt to wait for Japan’s parliamentary vote on a new PM.

The Japanese Yen (JPY) turns lower against the US Dollar (USD) for the third straight day on Tuesday, though the downside seems limited ahead of Japan's parliamentary vote on a new Prime Minister. Sanae Takaichi is all but certain to become Japan's first female premier following an alliance with the Japan Innovation Party (JIP), known as Ishin. This fueled speculations about more fiscal stimulus and that the Bank of Japan (BoJ) could delay raising interest rates further, which, in turn, is seen acting as a headwind for the JPY. Moreover, a generally positive tone around the equity markets turns out to be another factor driving flows away from the safe-haven JPY.

Meanwhile, investors seem convinced that the BoJ will stick to its policy normalization path amid sticky inflation and a resilient economy. This marks a significant divergence in comparison to dovish Federal Reserve (Fed) expectations, which fails to assist the USD to build on its modest gains registered over the past two days and could keep a lid on the USD/JPY pair. In fact, traders have fully priced in two more interest rate cuts by the Fed this year and the resultant narrowing of the Japan-US rate differential favors the JPY bulls. However, the uncertainty over the timing of the next BoJ rate hike warrants caution before positioning for any meaningful gains.

Japanese Yen bulls remain on the sidelines as more expansionary fiscal policies could further delay BoJ rate hikes

The ruling Liberal Democratic Party and Japan Innovation Party, known as Ishin, agreed to form a coalition Monday. Investors now await Japan’s parliamentary vote this Tuesday, which would see Sanae Takaichi become the first female Prime Minister.

The development fuels speculations about more expansionary policy in Japan, which could allow the Bank of Japan to delay raising interest rates further. This, in turn, fails to assist the Japanese Yen to attract any meaningful buyers during the Asian session.

The coalition holds a combined tally of 231 in the lower house, short of the 233 needed for a simple majority, suggesting that the government would need cooperation from other parties to pass any legislation. This keeps a lid on the so-called "Takaichi" trade.

Inflation in Japan remains at or above the BoJ’s 2% target for more than three years, and the economy grew for a fifth straight quarter through June. Moreover, BoJ Board Member Hajime Takata said on Monday that Japan has roughly achieved the price target.

This follows BoJ Deputy Governor Shinichi Uchida's remarks on Friday, reiterating that the central bank will continue raising rates if economic and price developments move in line with its forecasts. This keeps hopes alive for an imminent rate hike this year.

In contrast, the CME Group's FedWatch Tool indicates that traders have fully priced in a 25-basis-points rate cut at each of the US Federal Reserve's policy meetings in October and in December. This could undermine the US Dollar and cap the USD/JPY pair.

The Senate on Monday voted against reopening the US government for the 11th time, extending the shutdown to a third week as Democrats and Republicans remain at odds and unable to resolve the deadlock. This, in turn, contributes to capping the buck.

US President Donald Trump set the tone for his upcoming meeting with China's President Xi Jinping. Trump said that the two countries would strike a fantastic deal and warned that failure to reach an agreement could see China face potential tariffs of 155%.

On the geopolitical front, Ukrainian drones struck major gas processing plants in southern Russia. Trump said on Sunday that the Donbas region of Ukraine should be cut up, leaving most of it in Russian hands, to end a war that has dragged on for nearly four years.

USD/JPY could climb further towards testing the 151.75 confluence hurdle

The emergence of some dip-buying and a move back above the 151.00 mark favors the USD/JPY bulls. Adding to this, positive oscillators on 1-hour/daily charts back the case for a further appreciating move towards the 151.75 confluence – comprising the 61.8% Fibonacci retracement level of the recent decline from the monthly peak and the 200-hour Simple Moving Average (SMA). A sustained move beyond the latter should allow the USD/JPY pair to surpass the 152.00 mark and climb further towards the next relevant hurdle near the 152.25 supply zone en route to the 153.00 mark.

On the flip side, the 150.50-150.45 region, or the Asian session trough, might continue to act as an immediate support ahead of the 150.25 zone, or the 23.6% Fibo. retracement level and the 150.00 psychological mark. A convincing break below the latter might expose the 149.40-149.35 area, or a nearly two-week low touched on Friday. The USD/JPY pair could extend the fall further towards the 149.00 round figure before eventually dropping to the 148.45-148.40 strong horizontal resistance-turned-support.