The USD/JPY pair is in a critical phase, with its recent recovery from this month’s low of 151.90 being closely watched by market participants. The recovery has so far managed to overlook the bearishly diverging yield spreads, largely because much of the initial decline was attributed to suspected intervention by Japanese authorities. However, the challenge now lies in whether the pair can surpass the remaining 61.8%, 76.4%, and 100% retracement levels of the recent slide, which are positioned at 157.08, 158.20, and 160.24, respectively. The outcome of Wednesday’s U.S. CPI and retail sales data will be pivotal in this regard. Should these data points rise more than forecast, including any upward revisions, it could provide the necessary impetus for USD/JPY to break above these key resistance levels. Conversely, if the data disappoints, showing surprisingly soft figures, the pair could face pressure, testing the support around 155.50/00. This support is crucial as it could either reinforce the recent consolidation or signal a potential further decline.

The yen continues to be the weakest among the major currencies, a situation compounded by the Bank of Japan's (BoJ) slow approach to exiting its ultra-easy monetary policies. The Fed-BoJ rate spreads, currently priced to reach 4.66% by year-end, further add to the yen’s weakness. Recent Producer Price Index (PPI) data and comments from Federal Reserve Chair Jerome Powell had a limited net impact on these spreads or the USD/JPY pair, as the market remains cautious ahead of the CPI and retail sales releases. There was a brief spike in USD/JPY to 156.70 in response to PPI figures coming in well above forecasts, but the effect was short-lived as deep downward revisions quickly tempered the initial enthusiasm, leading to a fade in Treasury yields and the dollar. Currently, USD/JPY is trading near its pre-PPI levels, showing marginal gains on the day and consolidating above the 50% Fibonacci retracement of the recent sharp drop from 160.20 to 151.90, which was influenced by suspected interventions. Notably, since the day after the May 1 peak at the 1990’s high of 160.50, the yield spreads between the 2-year and 10-year U.S. Treasuries and Japanese Government Bonds (JGBs) have decreased by 29 basis points (bps) and 30 bps, respectively, now standing at 4.49% and 3.51%. This retreat in yield spreads underscores the complex dynamics at play, with USD/JPY poised at a critical juncture dependent on upcoming economic data releases.