USD/JPY drops to pick-up buyers at a 50% retracement to test critical 107.20 resistance

• USD/JPY has started out testing both sides of a critical structure.
• Bulls are back in the driver's seat with the mid 107s in focus.

USD/JPY had started out the week on the backfoot, opening below trendline support with a bearish gap albeit within the bullish territory marked by momentum indicators.

However, the pair has recently recovered to test a critical resistance level at 107.20 which guards a run back to recent 107.40s highs. 

The pair accumulated a bid on Friday, rising from a low of 106.80 and had marked a high of 107.36 before sliding back to 107.10 and closing above the figure. 

US data releases were broadly in line with expectations, but the US dollar firmed despite the renewed climb in US COVID-19 cases. Instead, it was the stock market which bore the brunt of risk-off, with the S&P 500 closing down 2.4% and the Dow down 2.8%.

The decoupling of the yen and US stocks may only last so long, however, as markets weigh the pending risks into month-end on what has been a very solid quarter for the US benchmarks. Any further profit-taking could well boost flows to the safe-haven yen. 

US 10-year Treasury bond yields fell to their lowest yield since mid-May on Friday which will be an additional supporting element in any subsequent flows to the yen. 

A second wave of COVID-19

At this juncture, it is also questionable as to how well the greenback can fare in the face of the second wave of COVID-19 in the US which shows no signs of slowing.

• Record daily US COVID-19 cases are a serious problem for the US dollar

"Confidence in the ‘recovery’ trade is being challenged again and whilst policy-makers have implemented huge fiscal, monetary and credit measures, the magnitude of that policy support is unlikely to be repeated if the health situation really deteriorates on a widespread basis," analysts at ANZ Bank explained. 

Financial market behaviour will critically depend on how the path of COVID-19 infections in the US unfold in the coming days and weeks. 

The market will also be nervous over the easing in travel restrictions across Europe last week, allowing holidaymakers flock to popular destinations. The European COVID-19 crisis spread wildly after the half-term break in February.

Meanwhile, in the week ahead, the Japanese calendar sees retail sales, today, and industrial production for May and on Wednesday, the 2Q release of the Bank of Japan’s Tankan business survey. 

As for the US, Nonfarm Payrolls, manufacturing ISM and consumer confidence will be a focus. 

We also have key speakers in the likes of the Federal Reserve's Jerome Powell and Williams as well as Steven Mnuchin who will be testifying before the House on Tuesday.

Additionally, any developments in Hong Kong could play a key role in financial markets this week considering the new HK security legislation being signed into law which could prompt further retaliation from the West. 

USD/JPY levels

There is potential for a continuation of the long run in the pair, with an interest from the bulls picking up the dollar in the bottom of the 107 handle and at a 50% mean reversion of Friday's range.

There could be a retest of the late June structure around 107.40/45.

However, a test of 107.20 will need to be seen and bulls will need to overcome the high levels of volume in that area. 

On the other hand, continued failures to overcome the sellers below 107.20 will likely give rise to a push to the downside.

A break of 107.08 and the current support could lead to a test back below the figure.

Higher volume accumulates around a 618% retracement of the 23rd June bullish impulse between 106.60/50.