USD/JPY extends breakdown on dovish Fed, heightened geopolitical tensions

USD/JPY continued to breakdown on Thursday as the US dollar came under some pressure after Wednesday’s release of dovish-leaning minutes from the Federal Reserve’s last meeting, and the safe-haven Japanese yen received a boost on heightened geopolitical tensions.

The market’s dovish interpretation of Wednesday’s FOMC minutes was prompted in part by a statement in the minutes which asserted that "a temporary period of inflation modestly above 2 percent would be consistent with the Committee's symmetric inflation objective." Though the Fed also indicated a likely rate hike in June, as has been widely expected, the indication that inflation would be allowed to rise above 2% hinted that the central bank under Fed Chair Jerome Powell may not be as aggressive in its tightening path as previously anticipated. This helped to give the previously rallying US dollar some pause as higher US interest rate expectations took a moderate hit.

Meanwhile, geopolitical uncertainties have increased due to several factors, including the election of a new coalition government in Italy that pairs an anti-establishment movement with a right-wing party, which raises the risks of political/economic instability as well as protectionism in the Eurozone. Also, US President Trump on Thursday canceled the previously scheduled June summit with North Korean leader Kim Jong Un, which had been slated to be held in Singapore. Citing recent instances of "tremendous anger and open hostility" on the part of Kim, Trump threatened "massive and powerful" nuclear retaliation should North Korea deploy any of its own nuclear capabilities. This rather sudden turn of events in a previously progressing negotiation process caused some increased volatility in equity markets on Thursday, and boosted perceived safe-haven assets like gold and the Japanese yen.

The combination of heightened geopolitical tensions supporting the yen and slightly lower interest rate expectations pressuring the dollar prompted USD/JPY to break down sharply below a key uptrend support line extending back to March’s long-term lows below 105.00. The current trading week has seen USD/JPY drop from key resistance around the 111.00 level down to its current position just above the 109.00 handle. With any continued pullback for the overbought dollar or escalation of geopolitical tensions, the USD/JPY breakdown could be poised to extend, with the next major downside target residing around the key 108.00 support area.

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