Last week saw a significant increase in USD/JPY, with the pair rising over 200 pips on Friday alone, closing near ¥157.7–¥157.8, approaching the 2025 high. Weekly movements contribute approximately 1.2%–1.3%, continuing a two-week upward trend and maintaining the dollar’s strong position against the yen. This is occurring within a broader context. The US dollar index recently exhibited a V-shaped recovery, dipping below 98 to a low of approximately 97.87 earlier in the week, before reversing course to close near 98.75, reflecting an increase of about 0.36% for the week. Simultaneously, the yen has emerged as the weakest major currency among the G10, with all significant pairs recording increases against it. The outcome illustrates a typical macro divergence scenario: the dollar is gradually strengthening, not due to a significant shift towards hawkish policies from the Fed, but rather because US economic indicators continue to show resilience, while Japan is indicating a commitment to maintaining negative real rates for an extended period. The USD/JPY represents the most straightforward indication of that disparity.
Recent US macro data presented a dovish inclination on the surface, yet it failed to undermine the dollar’s strength. The headline CPI recorded a year-on-year increase of 2.7%, falling short of the anticipated 3.1%. Meanwhile, core CPI decreased to 2.6%, marking its lowest level since early 2021. Average hourly earnings increased by just 0.1% month-on-month, falling short of the 0.3% consensus, indicating a reduction in wage pressure. Non-farm payrolls met expectations, and the unemployment rate increased to 4.6%, the highest level since 2021, indicating a cooling labor market without a significant downturn. In light of the recent trends in inflation and wage growth, Fed-funds futures continue to reflect expectations of approximately two 25-basis-point cuts in 2026, amounting to a total of around 50 basis points. The timing for the initial adjustment has been shifted to mid-year rather than the upcoming months. The likelihood of a cut occurring as soon as January is currently low, estimated to be in the mid-20s percentage range. The Fed is perceived to be implementing a gradual easing approach rather than hastily reducing rates. This maintains short-term US yields at a relatively high level, particularly in comparison to Japan, and supports the dollar aspect of USD/JPY, even as equities and metals exhibit a risk-on sentiment.
The primary catalyst for the recent movement in USD/JPY is the Bank of Japan. The BoJ has increased its policy rate by 25 basis points to 0.75%, marking the highest level since 1995, as it moves away from decades of near-zero nominal rates. At first glance, that appears to be favorable for the yen. The message conveyed was, in fact, contrary to expectations. The central bank reiterated that real interest rates are expected to stay negative in the near term and emphasized that the current policy remains accommodative. The outlook for future rate increases remains unclear, with market expectations now reflecting just one more 25-basis-point adjustment in the coming year, bringing the policy rate to a total of 1.0%. In the context of Japanese inflation exceeding 2%, the Bank of Japan is essentially committing to uphold negative real yields, in contrast to other major central banks that are approaching or have reached positive yields. Market participants responded precisely in line with expectations. Following a period of range trading near ¥155.5, USD/JPY surged past resistance, exceeding ¥157 and reaching intraday peaks near ¥157.8. Weekly gains of approximately 1.25% position the yen as the notable underperformer among major currencies. The BoJ’s assurance of no immediate plans to further normalize policy effectively encourages renewed carry trades financed in JPY.
Japan’s underlying inflation has surpassed US core inflation for the first time since 1979. Japan’s “core-core” CPI has surpassed the US core CPI, marking the conclusion of a 45-year trend where US prices consistently increased at a faster rate than those in Japan. Historically, that gap supported a highly accommodative Japanese policy and a persistently subdued domestic inflation environment. The current trend is showing signs of a shift. The most recent data indicates a slowdown in price growth in the US, whereas inflation in Japan remains elevated, bolstered by increases in wages and a gradual decline in deflationary mindset. This inversion is significant for the medium-term outlook regarding USD/JPY. A nation experiencing elevated inflation alongside negative real interest rates, supported by substantial government borrowing, would typically be anticipated to adopt a more assertive stance in defending its currency. The BoJ is indicating a stance of patience and flexibility, rather than a sense of urgency. Markets interpreted this as an indication that policymakers are prepared to accept a weaker yen, provided that the fluctuations remain orderly. The current dynamics for USD/JPY indicate that while Japanese inflation is showing signs of life, the monetary policy continues to lag significantly. This situation supports the perspective that the yen continues to be a favorable funding currency, even in light of the recent interest rate increase.