Yen's Rally May Not Last Amid Carry Trade Unwinding

The yen's recent rally has been driven by optimistic bets on tighter monetary policy and changes to the Government Pension Investment Fund, but this trend may not be sustainable in the long term. The USD/JPY pair broke through the key 155.0 level and extended its decline overnight, reaching as low as 153.0. This move appears primarily influenced by yen-specific factors rather than a broader shift in sentiment towards the dollar.

The current volatility makes it risky to try to catch the falling knife, particularly given the scope for further carry trade unwinding. The next meaningful support level comes in at 152.0, where the yen rally stalled in January and February. A break below this level could open the way towards 150.0.

The broader USD sentiment remains affected by the yen's rise, but has room to improve. Strong and elevated energy prices remain supportive of the dollar, yet markets are only pricing around 15bp of tightening for September. The coming week may bring a clearer picture of the dollar's prospects.