Yen Weakens After Fed's Hawkish Rate Hike; Market Eyes BOJ's Signal to Offset Yield Gap

On Wednesday local time, the Federal Reserve raised interest rates for the first time in nearly three years and signaled further policy tightening, directly impacting the yen, which had already strengthened significantly.

Following the Fed's move, the yen briefly depreciated by 1% overnight, with USD/JPY rising to 156.42. Traders currently expect the Fed may raise rates another three times by mid-next year.

This means that even if the Bank of Japan (BOJ) raises rates as expected this Friday, the US-Japan yield differential is likely to remain at a high level, and pressure on the yen will not easily dissipate.

BOJ Faces Challenge of Balancing Rate Hikes and Hawkish Signals

Glenn Yin, Research Director at ACCM in Melbourne, said the BOJ faces the challenge of raising rates while sending hawkish signals "to minimize damage."

He believes that if the BOJ disappoints the market, the risk of USD/JPY touching 160 in the short term cannot be ruled out.

25-Basis-Point Hike Already Priced In

Currently, overnight index swaps have almost fully priced in a 25-basis-point rate hike by the BOJ this Friday.

As a result, market focus has shifted from "whether to hike" to "what comes after the hike."

Investors will closely watch Governor Kazuo Ueda's post-meeting press conference for clues about the future pace and magnitude of rate hikes.

Hawkish BOJ Policy Board member Hajime Takata has previously not ruled out the possibility of unconventional or consecutive rate hikes.

Rinto Maruyama, Senior Rates and FX Strategist at SMBC Nikko Securities, believes that renewed weakness in the yen actually provides the BOJ with grounds to emphasize upside inflation risks.

He noted that rising oil prices could further strengthen the case for BOJ policy tightening.

However, Maruyama thinks Friday's hike may be sufficient to bring Japan's policy rate into the estimated neutral range, so the BOJ may not signal a 50-basis-point hike or consecutive increases.

If the meeting is ultimately interpreted by the market as dovish, he sees the next target for USD/JPY at 158.

The Real Risk for the Yen Lies in the US-Japan Yield Differential

The divergence in policy pacing between the BOJ and the Fed is key to the yen's subsequent trajectory.

If the market perceives that the BOJ's tightening cycle cannot keep pace with the Fed, the yen will come under renewed pressure.

Maruyama expects that if US rates rise faster than Japanese rates in the future, USD/JPY could gradually return to 160.

Earlier this month, the yen experienced notable appreciation. At that time, markets bet on accelerated BOJ tightening, unwinding of yen carry trades, and speculation that Japanese pension funds might increase domestic asset allocations, all of which further drove the yen higher.

But this rally also caused losses for some carry traders.

According to data from the US Commodity Futures Trading Commission (CFTC), leveraged traders reduced their net short positions in the yen during the week ending September 8. Meanwhile, the renewed rise in USD/JPY indicates that part of the positioning that had driven the yen's earlier gains has been unwound.

Intervention Risk May Limit Yen Downside

If the yen rapidly depreciates again, the Japanese government may face renewed pressure to intervene in currency markets.

Japan and the US have previously shown willingness to jointly intervene in markets, and US Treasury Secretary Scott Bessent has consistently signaled support for a stronger yen.

Therefore, even if the yen re-enters a depreciation channel, it may not repeat the previous rapid decline.

However, Friday's BOJ rate hike itself may still prove insufficient.

Akira Moroga, Chief Market Strategist at Aozora Bank Ltd., said the BOJ "may not adopt a stance as hawkish as the Fed," which could instead serve as an immediate catalyst for further yen weakness.

He views the area around 158.50, where the 200-day moving average lies, as the next critical threshold for the yen.

In other words, what the market now awaits is not merely whether the BOJ hikes rates by 25 basis points, but whether Governor Ueda can deliver sufficiently hawkish policy signals to offset the widening US-Japan yield differential pressure following the Fed's rate hike.

Source: Jin10 Data