The USD/JPY pair is currently positioned within the 155.10–155.60 range following a notable intraday decline of approximately 0.5%, which contributes to a two-day recovery of the yen. The pair has declined from recent peaks around 156.90–157.00 and is currently examining a robust support zone situated between 155.50–155.00, as the market adjusts to the altered rate differential following the Fed’s recent cut and an increasing likelihood of a Bank of Japan rate hike next week. The recent decline in USD/JPY can be attributed to the evident weakening in US labor data. Initial Jobless Claims surged to 236,000 for the week ending December 6, a significant increase from 192,000 the previous week and notably exceeding the 220,000 consensus estimate, and the four-week moving average has increased to 216,750, indicating a steady decline rather than a temporary surge. Continuing Claims decreased to 1.838 million; however, they still remain high compared to earlier in the year, highlighting that the re-employment process is not without its challenges, and this combination is precisely what the Federal Reserve aims to avoid following an extended period of tightening, further supporting the narrative that the labor market is experiencing a loss of momentum. For USD/JPY, softer labor data results in lower US yields, increased expectations for Fed cuts, and a weaker dollar component in the pair.
The Fed has now reduced rates by 25 bps, bringing the target range to 3.50%–3.75%, marking the lowest level since 2022 and the third consecutive reduction. Powell’s tone was evidently more cautious than what the markets anticipated, with minimal hawkish dissent within the FOMC. According to the sources, the market is currently anticipating at least two additional cuts in 2026, with approximately a 77% likelihood of further easing in the upcoming year. The dollar index has responded as expected, declining for the second consecutive session to reach a two-month low near 98.54. The US 10-year yield has decreased to approximately 3.9%, whereas the 10-year JGB is positioned around 1.1%, and the interest-rate gap that sustained USD/JPY throughout 2024 is contracting from both ends: the Fed is easing, while the BoJ is gearing up for an increase, which narrows the carry advantage and fundamentally weakens the bullish argument for USD/JPY exceeding the mid-150s. Market participants in Japan are approaching next week’s BoJ meeting with the expectation of a potential interest rate hike, and the pricing for a 25-bp move has shown stability above 80%, with multiple officials indicating a willingness to adjust policy away from emergency measures.
Kazuo Ueda has indicated that the likelihood of the BoJ’s baseline outlook on growth and inflation coming to fruition has been “gradually increasing.” The Corporate Goods Price Index continues to be elevated compared to historical norms, indicating ongoing inflationary pressures at the upstream level, and an increase of 25 basis points would elevate the policy rate to approximately 0.75%, the highest level since 2008, signifying a clear departure from the era of negative rates. For USD/JPY, this is not merely a superficial adjustment: it directly diminishes the rate differential, promotes Japanese capital repatriation at the margin, and bolsters a stronger yen as a funding currency, and the market must now acknowledge the potential risk that the Bank of Japan’s policy may no longer consistently lead to a depreciation of the yen. The yen cannot be reduced to a simple Fed/BoJ spread trade analysis. Japan’s macroeconomic landscape is complex, with revised GDP figures indicating that the economy contracted by 0.6% in Q3 on a quarterly basis and 2.3% year-on-year, marking the most rapid decline since Q3 2023, while Prime Minister Sanae Takaichi’s reflationary agenda relies on substantial fiscal stimulus, with anticipations of a supplementary budget in early January. The interplay of these factors brings forth valid apprehensions regarding public finances and the sustainability of long-term debt, potentially limiting the extent and pace of the yen’s appreciation. Simultaneously, the trends in wages and the anticipation of demand-driven inflation provide the Bank of Japan with the necessary political support to pursue normalization, and for USD/JPY, this indicates that the yen benefits from structural support due to policy normalization; however, substantial fiscal packages may lead to temporary increases in the pair as markets anticipate greater JGB issuance and elevated term premia.
The overall sentiment surrounding the dollar is unfavorable, as the dollar index has decreased approximately 0.1% today, reaching two-month lows as the markets assess a Federal Reserve that appears more concerned about potential downside risks to growth and employment rather than inflationary pressures. US equities have responded positively to the rate cut, with the Dow increasing by approximately 0.5% and the S&P 500 making slight gains, whereas the Nasdaq lags behind, and this combination—a weaker dollar, slight risk-on sentiment, and declining yields—diminishes a crucial support for USD/JPY. The market’s base case now anticipates a 25-bp hike from the BoJ “as early as next week,” bringing the short-rate ceiling nearer to 0.75% and indicating that the BoJ is truly in a phase of normalization. Concurrently, caution persists in the markets regarding Japan’s increasing fiscal influence under Takaichi, which may exert upward pressure on long-end JGB yields and somewhat diminish the yen-positive impact of elevated short rates, and in the case of USD/JPY, the dynamics present a complex scenario: the rise in JGB yields and the normalization of the BoJ suggest a potential strengthening of the yen, while increasing deficits and debt apprehensions can exert opposing pressures, leaving the balance of forces currently tilted to the downside for the pair as long as the Fed continues on a path of cuts.