Japanese Yen struggles amid political uncertainty and risk-on mood; downside seems limited

• The Japanese Yen underperforms against a weaker USD amid domestic political uncertainty.

• A positive risk tone further undermines the safe-haven JPY and supports the USD/JPY pair.

• The divergent BoJ-Fed policy expectations might cap any meaningful gains for the major.

The Japanese Yen (JPY) struggles to capitalize on the overnight bounce from a three-day low against a broadly weaker US Dollar (USD) and ticks lower during the Asian session on Friday. Investors now expect that domestic political uncertainty could give the Bank of Japan (BoJ) more reasons to go slow on interest rate hikes. Moreover, concerns that Japanese Prime Minister Shigeru Ishiba’s successor might put pressure on the central bank to keep interest rates low fail to assist the JPY in attracting any meaningful buyers.

Apart from this, the prevalent risk-on mood is seen as another factor undermining the safe-haven JPY. Meanwhile, the incoming macro data from Japan reaffirms market expectations that the BoJ will stick to its policy normalization path, which is holding back the JPY bears from placing aggressive bets. The US Dollar (USD), on the other hand, dives to its lowest level since July 24 amid bets for a more aggressive policy easing by the Federal Reserve (Fed). This should further contribute to capping the USD/JPY pair.

Japanese Yen bulls seem reluctant as political turmoil offsets BoJ rate hike bets

Japanese Prime Minister Shigeru Ishiba's resignation adds a layer of uncertainty, which could temporarily hinder the Bank of Japan from normalising policy and continue to act as a headwind for the Japanese Yen.

Wall Street's three major indices registered record closing highs on Thursday amid the growing acceptance that the US Federal Reserve will cut interest rates next week, which further undermines the safe-haven JPY.

The optimism over the US-Japan trade deal, an upward revision of Japan's Q2 GDP print, a rise in Producer Price Index, positive real wages, and a rise in household spending back the case for an imminent BoJ rate hike.

In contrast, traders ramped up their bets for three interest rate cuts by the Federal Reserve (Fed) this year after data on Thursday showed the US Weekly Initial Jobless Claims rose to the highest level since October 2021.

This comes on top of a weak US Nonfarm Payrolls report last Friday and provides further evidence of the softening labor market, which, in turn, overshadowed a higher-than-expected US consumer inflation reading.

The US Bureau of Labor Statistics (BLS) reported that the headline Consumer Price Index (CPI rose by a seasonally adjusted 0.4% in August, pushing the annual inflation rate to 2.9% compared to 2.7% recorded in July.

Meanwhile, the core CPI inflation, which excludes volatile food and energy prices, increased 0.3% for the month and 3.1% on a yearly basis in August, matching the previous month's print and consensus estimate.

According to the CME Group’s FedWatch Tool, traders have fully priced in a 25-basis-point rate cut at the FOMC meeting next week and see a greater chance of two more rate cuts, in October and in December.

The dovish outlook dragged the yield on the benchmark 10-year US government bond to a five-month low and the US Dollar to its lowest level since July 24, which could act as a headwind for the USD/JPY pair.

Traders now look to the release of the Preliminary University of Michigan US Consumer Sentiment and Inflation Expectations, which could influence the USD demand and provide some impetus to the currency pair.

USD/JPY technical setup backs case for emergence of fresh selling at higher levels

The overnight resilience below the 147.00 mark and the subsequent bounce favor the USD/JPY bulls, though neutral technical indicators on the daily chart warrant some caution. Hence, any further move up is more likely to confront a stiff resistance near the 148.15-148.20 region, or the overnight swing high. A sustained strength beyond, however, should pave the way for a move toward challenging the very important 200-day Simple Moving Average (SMA), currently pegged near the 148.75 zone. This is closely followed by the 149.00 mark and the monthly swing high, around the 149.15 region, which, if cleared decisively, will be seen as a fresh trigger for bulls.

On the flip side, acceptance below the 147.00 round figure would expose the 146.30-146.20 pivotal support. A convincing break below, leading to a subsequent breakdown through the 146.00 mark, could make the USD/JPY pair vulnerable to accelerate the fall to the 145.35 intermediate support en route to the 145.00 psychological mark.