Japanese Yen loses ground as Fed tightening bets boost US Dollar

USD/JPY extends its rebound on Tuesday and trades around 155.00 at the time of writing, up 0.41% on the day. The pair continues its recovery from levels below 153.00 reached last week, mainly supported by broad-based strength in the US Dollar (USD).

Investors are now preparing for the monetary policy decisions from the United States (US) Federal Reserve (Fed) and the Bank of Japan (BoJ), due on Wednesday and Friday, respectively. Expectations of monetary tightening on both sides of the Pacific put interest-rate differentials in focus and could fuel volatility in USD/JPY.

In the US, expectations of a Fed rate hike are strengthening following recently released robust economic data. According to the CME FedWatch tool, markets are pricing in a 92% chance of an interest-rate increase on Wednesday. A solid August employment report and the latest inflation figures have reinforced expectations that the US central bank will tighten monetary policy.

The latest private-sector employment figures provide additional support to this view. According to ADP's NER Pulse, US private employers added an average of 16.25K jobs per week over the four weeks ending August 29, up from a revised 12.25K previously. The acceleration suggests that the labor market retains some momentum and helps support the US Dollar.

In Japan, the Bank of Japan is also expected to raise interest rates by 25 basis points on Friday and could signal a faster pace of monetary policy normalization. The Japanese Yen (JPY), however, faces headwinds from rising global Oil prices, which increase import costs for Japan's energy-dependent economy. This factor currently limits the Japanese currency's ability to fully benefit from expectations of further BoJ tightening.

At the same time, several factors could continue to provide underlying support to the Japanese Yen, including expectations of more aggressive BoJ monetary tightening, the unwinding of global carry trades and signs that Japanese investors are repatriating foreign assets. These dynamics could limit further USD/JPY gains as markets await the two central banks' decisions.

Japanese Yen underperforms as markets eye BoJ guidance and key USD/JPY levels

Strategists at Scotiabank note that the Yen is soft into Tuesday’s North American session, with the currency “down 0.3% vs. the USD and underperforming all of the G10 currencies.” They highlight that a BoJ move is largely anticipated, stating that “a hike is widely expected and fully priced, with risk centered around the central bank’s tone and its guidance on the pace of future hikes with one additional hike almost fully priced before year end.”

On the technical side, Scotiabank continues to stress the importance of nearby support, remarking that “for USDJPY, we continue to highlight the importance of recent support around 153, with additional support expected closer to 152,” while “the 155 level remains an important level of anticipated resistance.” The bank adds that the “near-term focus remains centered on broader themes including the market tone and the Fed, as market participants balance their attention with domestic developments including the near-term release of trade data (7:50pm ET) and CPI (Friday) ahead of the BoJ policy decision at the end of the week.”