Tensions are mounting in the foreign exchange market as the USD/JPY pair takes a bold stance even before the highly anticipated address by the Federal Reserve Chairman at the renowned Jackson Hole Economic Symposium. With speculators already rallying behind the major currency, the implications of Jerome Powell's upcoming speech could set the stage for a fiery revival of the dollar, potentially spelling trouble for the USD/JPY asset.

Dollar's sudden rally

Yesterday, the USD/JPY pair managed to extend a robust upward momentum following a significant downturn just a day before. The impressive ascent of over 0.7% once again secured a comfortable position above the pivotal level of 146.

The driving force behind the dollar's resurgence hinges on the surge in 10-year US Treasury yields, fueled by hawkish sentiments expressed by American officials.

This Thursday, James Bullard, who recently vacated his position as the head of the St. Louis Federal Reserve, revealed in an exclusive interview with Bloomberg Television that the central bank might continue its hawkish trajectory.

Bullard argued that exaggerated recession fears have clouded the economic landscape and that the US could necessitate higher interest rates to effectively combat inflation as its economic growth persists.

Susan Collins, President of the Boston Federal Reserve, echoes Bullard's sentiment. In an interview with Yahoo, Collins admitted that the possibility of further interest rate hikes remains on the table, citing a stable inflation environment.

"We may need additional increments and we may be very near a place where we can hold for a substantial amount of time. But exactly where the peak is, I would not signal right at this point. We may be near but we may need to increase a little bit further," Collins emphasized.

Patrick Harker, Philadelphia Federal Reserve's leader, shares a similar stance, advocating for keeping interest rates higher for longer, though he remains cautious about further escalation.

USD's trajectory: looking ahead

Drawing from the insights of American policymakers, grounded in robust economic indicators and persistent inflationary pressures, futures traders are now speculating that US interest rates will continue to surpass the 5% mark until June 2024.

This projection bodes well for the dollar and holds the potential to fortify USD in the long term. Investors need to evaluate the feasibility of this scenario, and the forthcoming speech by the Fed chairman at Jackson Hole will undoubtedly offer crucial guidance.

If at a symposium in Jackson Hole, Jerome Powell aligns himself with his colleagues in their pursuit of sustained high interest rates, the dollar could receive a potent impetus for a renewed rally. Conversely, any deviation from this stance might steer the greenback towards concluding the week on a more subdued note.

The main risk lies in the possibility that Powell's tone will be less hawkish than the market expects. Powell does not necessarily need to adopt a dovish stance. Dollar weakening could result from a more moderate or cautious rhetoric, as noted by economist CBA Carol Kong.

Nevertheless, most analysts currently lean towards the view that Powell will make it clear that the Fed is not yet inclined to move towards easing and may even hint at another rate hike later this year if deemed necessary.

Risk factors

The dollar is trading against the yen at levels that prompted intervention by Tokyo last year. This morning, the Japanese government cautioned currency speculators that they will be closely monitoring yen movements during the Jackson Hole Symposium.

A sharp decline in JPY could force Japan's Ministry of Finance to intervene once again. If Tokyo intervenes in the market, this could lead to a sharp rise in the yen and a significant drop in the USD/JPY pair. In the most pessimistic scenarios, the pair could drop below 144.

Technical outlook

With the fundamental backdrop strongly favoring bulls, USD/JPY is poised to move upwards.

Buyers find encouragement in the formation of a bullish flag from a month ago. However, to bring the next strategic target around 154.00 into the spotlight, bulls need to confirm their positions at the 146.30 level.