The USD/JPY has recently concluded a volatile month that has complicated the straightforward narrative surrounding the pair. The price dropped to a weekly low around 152.09 before bouncing back to approximately 154.75, concluding January with a decline of about 1.3% and, importantly, remaining below the 155.00 threshold that had served as a key pivot for several months. The decline followed a previous rise to 159.45 from an October low around 147.06, a shift driven by yield spreads and a unilateral carry trade that is currently facing significant challenges. The price has rebounded from the 50-week EMA, indicating that the long-term uptrend remains intact; however, momentum has evidently shifted. Below 152.00, the next significant level is approximately 150.00, followed by a wider range between 145.00 and 140.00, which marked the last key intervention area. On the upside, 155.00 is currently the initial point of examination, with 158.00 and the 159.45 peak limiting any upward movement unless the underlying factors shift positively for the dollar. The essence of the narrative is that Japan has ceased to be the straightforward source of “free money” for global carry trades. The Bank of Japan is maintaining a policy rate of approximately 0.75%, but it is now clearly indicating that this rate is not a limit. Simultaneously, the government bond market has entered a realm previously deemed unimaginable under the former yield-curve-control framework. The 10-year JGB is currently trading around 2.25%, approximately twice the level from last year, while the 40-year yield briefly exceeded 4.0% before retreating to about 3.9% following a strong auction. The interplay of a live hiking bias alongside long-end yields exceeding 4% has transformed the JGB curve into a source of volatility rather than serving as a shock absorber. For USD/JPY, each incremental rise in Japanese yields diminishes the interest-rate edge that facilitated the ascent to 159+. The greater the contraction of the long-end spread, the less rational it is to finance in yen on a large scale, and the more precarious leveraged long-dollar positions turn when the spot begins to shift unfavorably.
In the short term, the BoJ’s Summary of Opinions and the language used by policymakers regarding the “neutral rate” will determine the extent to which USD/JPY can decline before buyers enter the market. If board members establish a neutral rate in the 1.5%–2.0% range, markets will interpret that as a guide for several increases throughout 2026. This suggests a significantly narrower rate differential between the US and Japan, even with gradual cuts from the Fed. The economic environment provides the BoJ with justification to adopt that stance. The projections for GDP and inflation have been adjusted upwards, and the forward guidance has transitioned from emergency measures to navigating a more typical economic cycle. Services PMIs have increased, and previous data indicated a rise in domestic demand. Simultaneously, December retail sales came in lower than anticipated, and household spending is projected to decrease by approximately 1.3% month-on-month following a 6.2% increase in November. The Bank of Japan faces the challenge of balancing wage growth and demand, given that private consumption accounts for nearly 55% of GDP and services make up about 70%. There is a risk that increasing rates and a stronger yen could negatively impact consumption. The current tension suggests a careful yet steady approach to tightening – a strategy that could weaken the carry trade without leading to an economic downturn, which is likely to be negative for USD/JPY in the medium term.
Officials are not solely focused on growth; they are also closely monitoring imported inflation. The depreciation of the yen is driving up energy and food prices, diminishing household purchasing power and resulting in a challenging scenario for Japan: escalating costs coupled with declining demand. That is why verbal warnings in the range of ¥155–¥160 are significant. The final slide in USD/JPY was hastened by public remarks indicating that intervention was still a possibility and that swift, unilateral movements would not be accepted. Market participants recall the 2024 carry-trade unwind that caused a significant decline in the pair, leading to a current hesitance to approach 160 without a robust support from the dollar. In practice, that establishes 155.00 as more than just a chart level; it becomes a significant political benchmark. Above 155.00, each additional yen rise heightens the likelihood of intervention headlines or direct measures. The risk-reward profile for new long-dollar positions has weakened, even prior to the next BoJ rate increase. Japan’s upcoming snap election on February 8 presents an additional factor contributing to the volatility of USD/JPY. Prime Minister Sanae Takaichi approaches the elections with strong personal approval and a clear plan to implement fiscal spending, all while managing a debt-to-GDP ratio close to 240%. The recent increase in USD/JPY, rising from approximately 147.06 in October to over 159 in January, was influenced in part by worries that substantial spending and significant issuance would devalue the yen in the long run. A decisive electoral victory would provide the government with greater flexibility to advance that agenda, which, at first glance, is unfavorable for the yen. Simultaneously, market participants are aware that increasing deficits and elevated long-term yields may compel the BoJ to expedite normalization, which would be favorable for the yen if the central bank adopts a hawkish stance. The interplay of increased fiscal risk alongside tightening pressures maintains a high risk premium, suggesting that any rallies in USD/JPY are likely to encounter selling pressure rather than follow a linear trend. Diplomatic factors are significant as well: any enhancement in relations with essential trading partners following the vote could bolster the yen through increased confidence and capital inflows.
In the dollar leg of USD/JPY, attention is moving from the magnitude of Fed cuts to when they will occur. The ISM Services PMI is projected to decrease from 54.4 to approximately 53.8, remaining in expansion territory but suggesting a deceleration in a sector that constitutes around 80% of US GDP. The labor market is expected to maintain an unemployment rate near 4.4%, while wage growth is anticipated to decrease from 3.8% year-on-year to approximately 3.6%. Weaker wages would indicate diminished consumer demand and a reduction in demand-driven inflation, creating a scenario that supports potential rate cuts later this year. However, Fed-watch data indicates that the market has already moved away from a stance of aggressive early easing. The likelihood of a cut in March 2026 has decreased to approximately 13.4% from more than 50% at the close of December, while the chances of a cut in June have fallen from around 84.5% to nearly 61.8%. The repricing contributed to the stabilization of the dollar following an initial selloff, yet it fails to reinstate the significant rate gap that propelled USD/JPY towards 160. Instead, it establishes a gradual compression as US yields decline while JGB yields remain elevated or increase further. The current situation for USD/JPY indicates a pattern of lower highs instead of a straightforward breakout.