Yen comeback puts fresh pressure on the US Dollar

The US dollar-Japanese yen (USD/JPY) pair has moved lower as expectations for another Bank of Japan (BoJ) rate hike strengthen the Japanese currency. The yen has climbed to around a seven-month high against the dollar, extending a recovery that began after Japanese authorities stepped into the currency market earlier this summer. Markets are now increasingly focused on whether the BoJ will follow that intervention with another increase in interest rates.

The shift in rate expectations has become an important part of the yen’s recovery. Markets are currently pricing roughly an 80% chance that the BoJ will raise rates by 0.25 percentage points at its 17–18 September meeting. Recent comments from policymakers have reinforced expectations that further tightening may be needed as Japan continues to deal with inflation and the effects of a weaker currency. The BoJ has confirmed that its next policy meeting will conclude on 18 September.

Higher Japanese rates could also weaken one of the forces that has weighed on the yen for years: the carry trade. Investors have long been able to borrow cheaply in yen and move that money into countries offering higher returns. As Japanese rates rise and the yen strengthens, that trade becomes less attractive, which can encourage investors to unwind those positions and add further demand for the currency.

Intervention remains another important part of the story. Japan’s Ministry of Finance confirmed that it spent ¥15.4 trillion intervening in foreign exchange markets between 30 July and 26 August, the largest such operation on record. Japan’s foreign exchange reserves subsequently fell by almost $80 billion in August. Unlike some previous interventions, the latest action has been followed by a sustained recovery in the yen, helped by changing rate expectations and speculation that more Japanese capital could return home.

The US side of the pair could now become increasingly important. August consumer inflation data are due on 11 September and will provide another indication of whether price pressures remain strong enough to influence the Federal Reserve’s next decision. With markets also reassessing the outlook for Japanese rates, USD/JPY is being pulled by changing expectations on both sides of the pair.

"The yen is getting support from more than intervention alone. Markets are becoming increasingly confident that higher interest rates are coming in Japan, which could make borrowing in yen less attractive and encourage some money to move back into the country. Attention now turns to US inflation and the Bank of Japan meeting, as both could change expectations for the interest-rate gap between Japan and the US," says Agustina Patti, Financial Markets Strategist at Exness.

For traders, US inflation data and the BoJ’s September meeting are likely to remain the main points of focus. After months in which intervention dominated the discussion around the yen, monetary policy is becoming a more important part of the story and could keep USD/JPY sensitive to any change in expectations over the coming sessions.