The latest US non-farm payroll data, which was released on Friday, boosted the US dollar against other currencies, particularly the Japanese yen. Could there be a new massive USD/JPY rally?

What pushed up USD?

Last week, USD was largely moving downwards. However, the US currency jumped on Friday following the release of US employment data, which exceeded expectations.

About 528,000 jobs were created in the US economy in July, well above the expected increase of 250,000 and the 398,000 rise registered in July.

Furthermore, unemployment fell to 3.5% in July from 3.6% in June. The number of unemployed decreased to 5.7 million.

The positive labor market data has fanned hawkish Fed expectations. As a result, the yield of US Treasury bonds have increased by 14 bps to 2.83%.

The rising gap between yields of US and Japanese sovereign bonds have led to a massive jump of USD/JPY.

The pair soared by more than 1.5% to its weekly high of 135.5 in its highest intraday gain in 7 weeks.

USD/JPY also found support in escalating tensions between China and the United States, which were triggered by the visit of US House Speaker Nancy Pelosi to Taiwan.

According to reports, Beijing is planning massive military exercises in the Taiwan Strait. On Sunday, Taiwan's Ministry of National Defense stated the army of the People's Republic of China was conducting a rehearsal of an invasion of the island.

Global financial markets remain under pressure amid the intensifying geopolitical conflict. US markets closed in negative territory on Friday, and investor demand for safe-haven USD notably increased.

Outlook for USD/JPY

The pair continued to hover near the weekly high of 135 early on Monday without making strong moves in any direction.

Falling yields of US Treasury bonds are currently weighing in on USD. The yield has retreated from its 2-week high it hit at the end of last week, as traders get ready for the US CPI data release on Wednesday.

Economists expect inflation to decline to 8.7% year-over-year in July from 9.1% in the previous month.

Falling oil prices are expected to cause inflation to go down. This could lead to more speculation regarding the Federal Reserve's further monetary policy course.

If inflationary pressure eases, the regulator could consider slowing down its monetary tightening.

Many analysts believe the release of July CPI data could increase expectations of a more dovish Fed policy, which would send the US dollar downwards.

"If US yields trend lower, then some of the upward pressure is removed from the currency pair," Jane Foley, strategist at Rabobank said. According to Foley, if yields decline, USD/JPY will not likely remain above 140 in the near future.

Several other analysts also see the US dollar slide down against the Japanese yen.

In mid-July, USD/JPY jumped by 38% from its March low. However, it has passed its peak, Bloomberg noted.

The pair is predicted to hover near 130 by the first quarter of 2023, even if the Bank of Japan continues its ultra-dovish monetary policy.

"US-Japan monetary policy divergence will no longer be a factor as markets have pretty much priced that in," Yukio Ishizuki, senior currency strategist at Daiwa said.

However, some analysts predict that USD/JPY could continue its rally, given the possible increase in BOJ's dovish sentiment.

Currently, the Japanese central bank is trying to accelerate economic growth back to pre-pandemic levels as soon as possible.

The Japanese economic recovery is under threat from rising import costs amid high energy prices.

According to the latest data, imports have surpassed exports by 20%, as Japan's trade balance worsened for the first time in 5 months.

The world's third-largest economy logged a current account deficit of 132.4 billion yen in June, down by 872 billion yen from the same period last year.

Amid stagnation risks, there is a growing possibility that the Bank of Japan may step its economic stimulus, which would be a very negative signal for Japanese yen.