USD/JPY surrenders a major part of intraday gains, up little around mid-109.00s

• USD/JPY struggled to capitalize on its modest intraday gains to the 109.75 area.
• The risk-on mood undermined the safe-haven JPY and extended some support.
• COVID-19 woes, sliding US bond yields capped any meaningful gains for the pair.

The USD/JPY pair retreated around 25-30 pips from the daily swing highs and was last seen hovering around mid-109.00s during the early North American session.

The pair gained some positive traction during the early part of the trading action on Tuesday and was supported by a combination of factors, though struggled to capitalize on the move. A solid rebound in the equity markets undermined demand for the safe-haven Japanese yen. This, along with sustained US dollar buying, extended some support to the USD/JPY pair.

That said, the recent sharp decline in the US Treasury bond yields, along with diminishing odds for an imminent Fed action in the near future, held the USD bulls from placing aggressive bets. In fact, the yield on the benchmark 10-year US government bond fell below the 1.16% threshold for the first time in over five months and capped the upside for the USD/JPY pair.

Meanwhile, the Fed funds futures showed the chances of a quarter-point hike in December 2022 fell to 58% on Monday from 90% on July 13, while the likelihood that the Fed raises rates in January 2023 dropped to 70% from 100% last Tuesday. Adding to this, the spread between 10-year and 2-year yields remained near February lows, signalling doubts about the growth outlook.

This comes on the back of growing market fears about the potential economic fallout from the fast-spreading Delta variant of the coronavirus, which should act as a tailwind for the JPY. The fundamental backdrop seems tilted in favour of bearish traders and supports prospects for an extension of this month's retracement slide from YTD tops, around the 111.65 region touched last week.

Technical levels to watch