Japanese Yen weakens at the start of a central bank-heavy week

• USD/JPY edges higher as Fed rate hike bets support the Greenback.
• Higher energy prices add to US inflation concerns and lift Treasury yields.
• Friday’s BoJ decision could determine whether the Japanese Yen resumes its recovery.

USD/JPY climbs on Monday as US Dollar (USD) demand picks up ahead of the Federal Reserve’s (Fed) interest rate decision on Wednesday. Attention is also on the Bank of Japan’s (BoJ) policy announcement on Friday, where a 25-basis-point rate hike is fully priced in, helping limit deeper losses in the Japanese Yen (JPY). At the time of writing, the pair trades around 156.40, up roughly 0.50% on the day.

Markets are increasingly convinced that the Fed will raise borrowing costs, with the CME FedWatch Tool showing a 90% probability of a quarter-point increase. The view is supported by recent US inflation data, which showed price pressures staying stubbornly above the central bank’s 2% target. Fed Chair Kevin Warsh also stressed the importance of restoring price stability during his speech at the Jackson Hole Symposium in August.

A Reuters poll published on Monday showed that 86 of 101 economists expect the Fed to raise its policy rate by 25 basis points to 3.75%-4.00% at the September 15-16 meeting, which would mark the first increase since July 2023. Among a smaller group of respondents, 37 of 70 expect at least one additional increase by the end of March 2027.

The US Dollar Index (DXY), which tracks the Greenback against a basket of six major currencies, trades around 99.53, up 0.45% on the day, after touching an intraday high of 99.74, its strongest level in nearly two weeks.

Higher energy prices due to escalating tensions in the Middle East are adding to concerns that inflation could stay elevated for longer. Reflecting these concerns, US Treasury yields extend their rise across the curve. The benchmark 10-year yield trades near 4.97% after briefly touching 5.00%, its highest level since October 2023.

The Japanese Yen has strengthened sharply since the start of the month amid expectations that the BoJ will tighten policy at a faster pace, narrowing the yield gap with other major economies. With a rate hike fully priced in, the focus will be on the BoJ’s forward guidance about the timing of future policy moves.

Yen faces downside risks as markets fully price BoJ hike and eye Fed signal

Analysts at ING expect the Bank of Japan to deliver a rate increase on Friday, noting that the BoJ "looks likely to hike rates by 25bp," with markets "fully discounting the move" and "little risk of a surprise hold." They add that, if anything, there is "a small outside chance of a larger 50bp increase," though such a move would likely be "met with some discontent from the growth-oriented government."

Despite the anticipated tightening, ING warns that "we see downside risks for the yen this week." A "hawkish Fed hike on Wednesday" could prompt "a rebuilding of speculative USD/JPY long positions," while the BoJ itself "may fall short of validating market expectations, with a December hike already fully priced in." The bank also flags a potential source of disappointment for JPY bulls, noting that "some JPY bulls may also be looking for an announcement on a domestic shift in GPIF portfolio allocation as early as this week and could be disappointed if none materialises."