USD/JPY: Double Top Near 158 Raises Pullback Risk - Here’s How to Trade It

• Bank of Japan hike lifts rate to multi-decade highs while yen remains range-bound.
• Markets price further Japan hikes as inflation stays elevated despite weak economic growth.
• USD/JPY risks a pullback toward 154.50 if the double top near 158 holds.
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Even before the holiday season began, the Bank of Japan held its final meeting of the year and, as expected, raised interest rates by 0.25%, taking them to their highest level in decades.

Despite this rate hike, the Japanese yen initially weakened against the US dollar and stayed stuck in a sideways range. After the meeting minutes were released, the yen recovered some ground as markets picked up signals that more rate hikes could come, since real interest rates in Japan remain deeply negative.

Inflation will stay the key factor to watch next year, as it has been running above the central bank’s target for some time. Still, major moves look unlikely before the year’s end, and the USD/JPY pair is likely to continue trading in a narrow range for now.

Will the Bank of Japan begin a full-fledged interest rate hike cycle?

With Japan moving away from ultra-low interest rates, markets are now trying to gauge how far the Bank of Japan might go with rate hikes next year. Minutes from the latest meeting suggest the board, led by Governor Kazuo Ueda, sees room to raise rates every few months, as long as economic data supports it.

The base case is at least two more rate hikes, which would take the policy rate to about 1.25%. The key factors to watch are inflation and economic growth. Growth remains weak, with the economy shrinking 0.6% year on year in the latest data, while inflation stays high. This creates a challenge for the central bank, since higher rates could slow the economy further.

Even so, Governor Ueda has sounded confident about Japan’s economic outlook. Markets may take that as a signal that another 0.25 percentage point rate hike in the first half of next year remains possible.

At the other end of the spectrum, the US economy looks much stronger based on recent data. Inflation slowed to a 2.7% year-on-year pace, while GDP grew faster than expected, rising 4.3% quarter on quarter compared with forecasts of 3.3%.

This picture suggests the Fed has room to keep cutting interest rates. At the same time, some softening in the labor market could limit how aggressive those cuts become. As a result, the chance of the Fed holding rates steady at its January meeting remains high, at over 81%.

USD/JPY Technical Analysis

So far, demand has lacked the strength to push prices to new highs, raising the possibility that a double-top pattern is forming around the 158 yen per dollar level.

If this scenario plays out, the first downside target would be the well-tested support near 154.50 yen per dollar, followed by the next support level around 153 yen per dollar.

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