The USD/JPY pair has returned to the 155–156 range following a significant round-trip influenced by central bank anticipations and political developments on both sides of the Pacific. In late January, the pair experienced a brief decline to approximately 152.1 following indications from the Bank of Japan regarding increased inflation and growth projections for 2026, along with suggestions that negative interest rates may soon be phased out. The decline of approximately 1.6% within a single trading session highlighted the cross’s sensitivity to any indications of Bank of Japan normalization. Since then, diminishing expectations for imminent Fed cuts and robust US data have propelled USD/JPY by over 3 big figures, bringing it closer to the upper limit of the 154–160 range that numerous analysts now identify as the “intervention danger zone”. On the Japanese front, the BoJ maintained its rates on 23 January with an 8–1 vote; however, the communication was not as accommodating as the headline implies. Revisions to growth and CPI projections for 2026 indicate an upward trend. Governor Ueda emphasized that should the current momentum in the labor market and services activity continue, a rate increase in the first half of 2026 could be considered. The S&P Global Japan Services PMI has increased from 51.6 in December to 53.4 in January, indicating growth in a sector that accounts for approximately 70% of GDP. In the latest PMI report, employment experienced its most rapid growth since April 2019, while service firms maintained an upward trajectory in selling prices despite a decline in input costs. The interplay of increasing headcount alongside expanding margins creates the ideal environment for the Bank of Japan to achieve sustainable wage growth and inflation driven by demand, rather than relying solely on external price pressures.
Concurrently, the fiscal position is shifting in a contrasting direction. Tokyo has introduced a ¥21.3 trillion stimulus package featuring a temporary suspension of the 8% consumption tax on food products, aimed at alleviating the financial burden on households due to rising prices and garnering support ahead of the snap election on 8 February. Public debt has surpassed 260% of GDP, and following a failed 20-year JGB auction in January, markets are actively assessing the limits of Japan’s balance sheet capacity. The outcome has led to a significant adjustment in the long end of the curve: 10-year yields have risen to approximately 2.38%, marking the highest level since 1999, while 30-year yields are around 3.63%, and 40-year bonds have surpassed 4.20% for the first time. The recent developments extend beyond domestic implications; they directly influence the fair-value assessments for USD/JPY, as interest rate differentials serve as the primary catalyst for this currency pair. The US side has experienced significant fluctuations. During a recent webinar, Donald Trump referred to the dollar’s softness as “great,” which resulted in a swift decline in the US currency and elevated EUR/USD above 1.2000. The significance of that political signaling lies in its ability to inform markets regarding the White House’s stance on the strength or weakness of the dollar. The impact of those remarks was somewhat mitigated when Treasury Secretary Scott Bessent addressed the latest FOMC meeting, reverting to a more traditional strong-dollar rhetoric, which aided the recovery of the greenback. Subsequently, Kevin Hassett’s comments indicated that the administration may be reconsidering the extent of the dollar’s decline, contributing additional uncertainty to the short-term trajectory of the USD.
The nomination of Kevin Warsh as the next Fed Chair has introduced an additional factor contributing to the strength of the dollar. Warsh is viewed as more doubtful regarding an extensive Fed balance sheet. The market has begun to factor in the potential risk associated with a Warsh-led Federal Reserve, which may lead to a more aggressive reduction of its approximately $6.6 trillion portfolio and a decreased tolerance for inflation exceeding targets. The recent sessions have seen the DXY supported by that expectation, contributing to USD/JPY’s recovery from the mid-152s back above 155, despite the persistent headline odds of a 2026 rate-cut cycle. In the short term, the primary macroeconomic influence on USD/JPY is the services sector of both economies. In Japan, the January services PMI stands at 53.4. Should another robust figure emerge on 4 February, it would bolster the perspective that domestic demand and employment are sufficiently resilient to accommodate a modest positive policy rate. A shift deeper into expansion territory, particularly if wage and pricing elements remain robust, would heighten expectations for a BoJ rate increase in the first half of 2026. In the US, projections indicate that the ISM Services PMI is likely to decrease from 54.4 in December to approximately 53.5 in January.
Services represent approximately 80% of US GDP, thus any unexpected downturn — particularly if the employment sub-index falls below the 52 threshold or the prices sub-index declines significantly from the 64-plus level — would reignite speculation regarding a rate cut in June. The likelihood of a March adjustment has decreased to below 10%, while the probability of a June reduction has declined from over 65% to approximately the mid-50s in light of more robust data emerging. Despite the repricing, the medium-term trajectory remains directed towards reduced Fed rates and a flatter yield curve, while the BoJ is gradually moving towards its first rate hike in years. The combination suggests a diminishing US–Japan interest rate gap in the coming months, which will likely create a long-term downside for USD/JPY once the situation stabilizes. The current political landscape is not merely a backdrop for USD/JPY; it serves as a significant catalyst for volatility. The upcoming snap election in Japan on 8 February serves as a de facto referendum on the prevailing combination of ultra-loose monetary policy and assertive fiscal expansion measures. The betting markets assign a probability of approximately 95% to Takaichi’s victory, reinforcing the anticipation of “Abenomics 2.0.” This scenario suggests an increase in stimulus measures, ongoing pressure on the Bank of Japan to adopt a cautious approach, and a readiness to accept a weaker yen to bolster exporters and the equity market. A landslide would signal an opportunity for increased spending and could drive USD/JPY into the 160–165 range, provided that global risk appetite remains strong. A result that falls short of expectations could temper those anticipations and, to some extent, bolster the yen.
The conclusion of the recent government shutdown in the US, along with the continuing debates surrounding tariffs and industrial policy, is significant as well. Whenever Washington engages in fiscal brinkmanship or indicates larger deficits, the long end of the US curve must adjust, which subsequently impacts the dollar through alterations in real yields. In the case of USD/JPY, the dynamics are straightforward: an increase in real US yields typically results in a stronger pair. However, should the fiscal narrative begin to appear chaotic while Japan moves closer to normalization, this correlation may reverse as investors look for safe havens and scrutinize the viability of US debt trends. Japanese officials have indicated that they are monitoring USD/JPY with great attention. Finance Minister Satsuki Katayama has indicated that Japan possesses “free hands” to tackle excessive currency fluctuations, a statement that typically signals impending measures. The New York Fed’s rate checks on USD/JPY in January indicate that authorities are laying the groundwork for future actions. Historically, individual interventions have demonstrated only a transient effect, as evidenced in the years 2022 and 2024. The rationale is clear: when the currency is generally in line with fundamentals, intervening in the market with a few billion dollars seldom alters the medium-term trajectory.
The distinction in this instance lies in the increasing discussions surrounding a synchronized operation between the US and Japan, reminiscent of the events in 2011. With USD/JPY trading just below 160 and fair-value estimates derived from rate differentials hovering around 148–152, the assertion that the yen is significantly undervalued is becoming increasingly difficult to overlook. Should the pair surge significantly into the 160–165 range, driven by a combination of election optimism and a robust DXY, the likelihood of coordinated intervention increases. This type of movement would not only initiate a temporary decline; it could also induce a significant squeeze in heavily populated carry positions, exacerbating the downside within a brief timeframe. In terms of positioning, an upside beyond 160 presents an increasing tail risk of a significant 5–10 big-figure reversal influenced by policy rather than data.