The dollar/yen pair is flexing its muscles once again. The currency pair strengthened by over 0.8% yesterday and continued its spectacular ascent overnight. As Asian trading kicked off today, the quote tested a new 10-month high at 147.8. Experts caution that the USD/JPY rally might intensify in the short term. What might trigger another spike in the asset, and how high might it climb?

Tailwinds for USD

The American currency that lost ground in the previous week found itself in perfect conditions for growth this time. The US dollar rose against a basket of major currencies by more than 0.6% yesterday, reaching 104.8, and intensified its upward momentum overnight, soaring to a 6-month high of 104.90.

The main driver behind the dollar's surge has been growing market fears about slowing global economic growth, following gloomy macroeconomic data from China and Europe. Data revealed that in August, China's services sector activity grew at its slowest rate in eight months, as weak demand continued to weigh on the world's second-largest economy.

Meanwhile, the Eurozone isn't doing any better. Last month, the PMI index, which reflects the services sector activity, plunged to 47.9 points, indicating a high risk of a recession in the European economy.

"Markets are becoming increasingly concerned about the deceleration of global economic growth, especially given the bleak picture in China and Europe. Against this backdrop, investors are turning to the US dollar as the most reliable safe haven," analyst Joe Manimba explained.

Another bullish factor for the greenback continues to be the hawkish stance of the Federal Reserve. Although futures traders currently price in a more than 90% likelihood of a pause in tightening at the September FOMC meeting, we cannot entirely rule out another rate hike in the US this year.

Last week's Nonfarm Payrolls report showed that the US labor market remains robust. This has bolstered investors' forecasts regarding an additional tightening round in November. Currently, the probability of such a scenario stands at 45%, whereas a week earlier, it was estimated at 40% by the futures market.

Further reinforcing the hawkish sentiments around the Fed's future policy was a statement made yesterday by Federal Reserve Board member Christopher Waller. Last Tuesday, the official suggested that markets might be mistaken in betting that the Federal Reserve has concluded its anti-inflation campaign.

"At present, I don't see anything that could prompt another hike in borrowing costs in the US. However, I wouldn't rush to conclusions and would prefer to wait for subsequent data. Experience shows this can sometimes be shocking and indicate stronger-than-expected inflationary pressures," stated the official.

In this context, the yield on 10-year US Treasuries surged by 8 basis points yesterday, hitting 4.26%. The yen was the primary victim of this sharp jump.

Overnight, the Japanese currency plummeted against the dollar by more than 1 yen. Additional pressure on JPY was exerted by the dovish remark from BOJ board member Hazime Takata. The official opined that the central bank should maintain its ultra-loose policy, given the prevailing high uncertainty surrounding inflation outlooks.

Such rhetoric intensified market concerns about the ongoing stark monetary divergence between the US and Japan, prompting high volatility in the dollar/yen pair.

Can USD/JPY rally go on?

The yen's overnight nosedive wasn't without consequences. The sharp decline in the Japanese currency triggered Tokyo's sternest warning about potential currency intervention.

On Wednesday morning, Japan's chief currency diplomat, Masato Kanda, stated that the government is prepared to take necessary actions if speculative movements around the yen continue.

Tokyo's verbal intervention helped JPY strengthen against the dollar. At the time of writing, the yen appreciated by 0.4%, settling at 147.06.

However, most analysts believe that in the near term, the major currency pair might retest its recent high and even scale new heights if the dollar receives another boost in the form of robust non-manufacturing sector business activity data from the US.

Currently, economists anticipate the August ISM non-manufacturing business activity index to remain above 50, given it has been consistently holding above this threshold for 37 of the past 38 months.

In July, the ISM Non-Manufacturing index stood at 52.7. If the reading once again surpasses 52 points, it would not only signify the ongoing growth of the US economy but also point towards persistent inflation.

Consistently high economic activity in this sector implies that price growth will remain steady and is unlikely to wane anytime soon. "Such a prospect could amplify hawkish sentiments in the market regarding the Fed's forthcoming tactics," noted analyst Yohai Elam.

In his view, if today's statistics turn out to be particularly robust, it will bolster the dollar across the board, including against the yen.

Of course, given the high risk of currency intervention, the USD/JPY momentum might not be as intense as other dollar majors. However, we should not rule out a potential spike in the quotes.

Many analysts believe that the Bank of Japan won't take measures to defend its currency unless the yen drops against the dollar to 150. Based on this assumption, we may say that the USD/JPY pair still has room to grow.

From a technical standpoint, the pair is still leaning toward an upward trajectory. The next target for the bulls will be the psychologically important mark of 148.00, followed by last November's high of 148.82, and then the key level of 149.00.

For sellers to gain the edge, they now need to break below 146.09. Breaching this level would pave a quick path to the 144.62 mark and from there, down to 144.00.