The dollar/yen pair has caught another upswing, reaching its yearly high of 139.38 yesterday and setting its sights even higher today. With the primary target of the dollar bulls now set at the significant level of 140, investors are wondering if the major currency can overcome this level in the near future and what obstacles may hinder its progress.

How the debt ceiling crisis affects USD:

Despite the increasing risk of default and recession in the United States, the greenback continues to strengthen. This trend is driven by investor concerns about slowing global economic growth.

Many market participants currently believe that the collapse of the American economy would have catastrophic consequences worldwide. To safeguard their portfolios against a potential global crisis, traders prefer to buy USD, which is considered a safe-haven asset.

Yesterday's developments failed to bring the long-awaited relief to the markets. During a four-hour meeting, House Speaker Kevin McCarthy and the White House administration once again failed to reach an agreement on the US debt ceiling, which could prevent a default and its dramatic consequences.

It should be noted that for a positive outcome, a deal between Republicans and Democrats must be reached by early June.

Earlier, US Treasury Secretary Janet Yellen warned that the United States could run out of funds to pay its bills in early summer, leading to bankruptcy.

Yesterday, Republican Kevin McCarthy expressed optimism once again about reaching an agreement. He stated that members of Congress still have time to finally find common ground and strike a deal by the deadline.

However, the confidence of the American politician did not affect analysts' opinions. Rating agencies Moody's and Fitch have recently issued warnings and downgraded the US debt rating to a negative status of "AAA."

These actions further intensified fears of an impending crisis and dampened demand for risk assets, while making safe-haven assets more appealing. Initially, the yen emerged as one of the primary beneficiaries, but the dollar quickly regained its leadership position.

At the end of yesterday's trading session, the USD/JPY pair surged by 0.5% to reach its highest level in a year at 139.3. Meanwhile, DXY strengthened against a basket of major currencies by 0.3% to reach a two-month high of 104.01.

According to analyst Tony Sycamore, Fitch's decision could serve as a catalyst for further dollar growth. He expects the greenback to strengthen by an additional 2% in the short term to reach the level of 106 if an agreement to raise the debt ceiling is not reached in the coming days.

Some experts believe that the dollar's rise as a safe haven will help USD/JPY overcome the psychologically important threshold of 140 in the near future.

However, the primary catalyst for the major currency will still be market concerns about maintaining a strong monetary and credit divergence between the United States and Japan. If these concerns continue to grow, it will lead the dollar-yen pair to new significant highs in the near future.

How can monetary policy impact the dynamics of USD/JPY?

Many experts attribute yesterday's surge in the dollar against the yen to a notable strengthening of the market's hawkish expectations regarding the future monetary and credit policy of the US Federal Reserve.

Futures traders currently assess the probability of another 0.25% increase in borrowing costs by the US regulator at over 35%, compared to less than 20% earlier this week.

What prompted investors to change their forecasts? Firstly, it was the more hawkish-than-expected minutes of the May FOMC meeting. Secondly, it was the aggressive rhetoric of the US central bank officials.

The released minutes from the Federal Reserve on Wednesday showed that many officials generally agreed that the need for further interest rate hikes had become less evident.

However, some Federal Reserve members warned that the regulator should not completely rule out the possibility of another round of tightening, considering the persistently stable nature of inflation.

Yesterday, Federal Reserve Board Governor Christopher Waller echoed the same sentiment. He stated that he would not support the idea of ending rate hikes until he sees clear evidence that inflation is approaching the 2% target.

Against this backdrop, the yields of 2-year and 10-year US government bonds demonstrated a parabolic rise, reaching their highest level since mid-March.

A sharp increase in US Treasuries yields exerted significant pressure on the yen, which was already in an unfavorable position due to the dovish policy of the Bank of Japan.

Despite the steady rise in consumer prices in the country, the Bank of Japan (BOJ) continues to maintain extremely low interest rates (-0.1%) and has no plans to raise them in the near future as it considers the current inflation to be a temporary phenomenon.

If in the foreseeable future the market receives confirmation that both the BOJ and the Federal Reserve are going to stick to their policies in June, this could further drive the USD/JPY pair.

Technically, the major currency currently has a good chance of reaching the high from early November at 142.25. This would be possible if the price surpasses the 140 mark in the near future and holds above it.

However, if the fundamental picture dramatically changes and becomes negative for the dollar|yen pair, we could see a sharp decline.

The biggest risks for the USD/JPY pair are the strengthening expectations of a pause in the current tightening cycle of the Fed, as well as the rise in speculation about a possible adjustment in the yield curve control (YCC) policy in Japan.

If the market becomes more confident that the BOJ will make changes to its YCC at its upcoming meeting in June, it could trigger a strong rally in the yen. According to analysts at Societe Generale, in such a scenario, the dollar/yen pair could plunge by 7% from current levels to 130.

To profit from this situation, SocGen recommends that investors buy inexpensive two-month digital put options with a strike price of 134 per dollar and a knock-out barrier at 129.