For the second consecutive day, the USD/JPY pair is trading in positive territory, after rebounding from its steepest drop in the last two months. Let's delve into the factors driving the pair and evaluate whether it can sustain this upward momentum in the short term.

Why is JPY retreating?

This morning, USD/JPY continues to build on its recovery from a weekly low of 145.91 recorded last Monday.

The initial spike in the yen's value against the dollar can be attributed to unexpectedly hawkish comments by Bank of Japan's Governor, Kazuo Ueda.

In a recent interview, Ueda hinted that the BOJ might abandon its negative interest rate policy once inflation consistently approaches the 2% target.

Given that Japan's core CPI has been above the central bank's target for 16 consecutive months, investors interpreted Ueda's remarks as a hint of an impending shift in the bank's monetary policy.

As of September 11, indexed overnight swaps suggested that the BOJ might move out of the negative zone by January. This is in stark contrast to post-July BOJ meeting sentiments, where traders believed a rate hike would only materialize in September 2024.

However, many economists surveyed by Bloomberg reacted to Ueda's statement with a fair share of skepticism. The majority felt the central bank wouldn't start normalizing its monetary policy until at least the third quarter of next year.

Now, as the initial euphoria has settled and experts have weighed in, market participants are becoming more grounded, negatively impacting the yen's momentum. Yesterday, the USD/JPY strengthened by nearly 0.4%, reaching 147.15.

"The fundamental factor pressuring the yen is back in play. It seems the market has realized that Ueda's statement might not be as hawkish since the BOJ's chairman didn't make any specific promises," commented currency strategist Alvin Tan from RBC Capital Markets.

Furthermore, Ueda recently reiterated that the BOJ remains committed to its dovish stance and has no plans to raise interest rates in the near future given it is still far from meeting its inflation target.

"Even if the BOJ continues to send hawkish signals, the interest rate disparity between Japan and the US will remain significant, especially since the Federal Reserve shows no signs of easing its monetary policy. Under such circumstances, it is going to be challenging for the yen to maintain a bullish trajectory," explained analyst Karl Schamotta.

Could USD surge further?

Most experts believe that in the short term, the USD/JPY pair will continue its recovery and might even revisit recent highs. A strong US inflation report for August could be the catalyst propelling the US dollar forward.

Consumer price growth statistics are set to be released today. Economists are forecasting an acceleration of the annual headline inflation from 3.2% to 3.6% and a slowdown of its core component from 4.7% to 4.3%.

If headline inflation indeed demonstrates a robust upward trajectory and the core CPI remains above 4%, this will indicate sustained price growth in the US. Most likely, this will impact market forecasts regarding interest rates.

Of course, a heated inflationary release is unlikely to alter traders' evaluations of the September FOMC meeting. Currently, over 90% of investors believe that the Fed will refrain from tightening this month.

However, strong statistics could elevate market expectations for further rate hikes this year. A strengthening of hawkish sentiment will push the dollar higher across the board, including against the yen.

"For the USD/JPY major, how the 10-year US Treasury yields react to the inflation data will be particularly important. Currently, the yield difference between American bonds and their Japanese counterparts is about 40 basis points. If today's statistics significantly widen this gap, dollar bulls could substantially move towards their strategic goal – the 150 mark," said SocGen analyst Keith Jacks.

Meanwhile, his colleague Clifton Hill recently predicted that in the coming months, the yield on 10-year US Treasury bonds could soar from the current 4.3% to the highest level since 2007, at 5%.

The yield rise of US bonds will be driven by growing market expectations regarding further tightening in the US against the backdrop of sticky inflation.

This could lead to a strengthening of the dollar index by another 5% by year-end, implying that the greenback has a chance to appreciate to nearly 155 against the yen.

Technical analysis of USD/JPY

Given that oscillators on the 4-hour chart are beginning to gain positive momentum, and technical indicators on the daily chart confidently remain in bullish territory, the major currency pair is set to move upwards.

A return to 147.85, the highest level since November 2022, seems quite likely at this moment. If buyers manage to overcome the key level of 148.00, it would pave a swift path to the next significant barrier of 148.70–148.80.

On the flip side, a convincing bearish breakout below 146.35 could trigger aggressive technical sales and lay the groundwork for a more profound corrective decline. This could lead to a drop in USD/JPY to 146.00, as well as testing the intermediate support of 145.30 on its way to the psychologically significant mark of 145.00.