Will the yen's appreciation rebound be short-lived? The USD/JPY faces a crossroads

Recently, the yen exchange rate has experienced a dramatic turnaround, with the USD/JPY falling back from the high of 156. Market analysts generally believe that a more complex game of chess is behind this shift.

Policy Expectation Reconfiguration, Changes in the Interest Rate Differential Pattern

Rumors of a rate hike by the Bank of Japan in December are rampant, with market expectations that the Bank of Japan has nearly a 50% chance of raising interest rates in December and January. This shift is directly driven by the convergence of two major policy signals: on one hand, the Japanese government maintains a firm stance, with Prime Minister Fumio Kishida explicitly stating that they will closely monitor the foreign exchange market and are prepared to intervene at any time; on the other hand, expectations of a Fed rate cut are rising, and this “one up, one down” expectation gap has driven the narrowing of the US-Japan interest rate differential.

Carol Kong, an analyst at Commonwealth Bank of Australia, pointed out that the cautious Bank of Japan might choose to wait until the parliament passes the budget bill before taking action. The advantage of this approach is that it allows more time to observe wage negotiations and avoids hasty decisions.

The Magnitude of Rate Hikes Determines the Yen’s Direction

On the surface, the USD/JPY correction seems to indicate an imminent reversal of the yen. However, UBS foreign exchange strategist Vassili Serebriakov poured cold water on this optimism: a single rate hike alone is far from enough to change the long-term trend of yen depreciation. He emphasized that unless the Bank of Japan adopts an aggressive rate hike stance and commits to continuous hikes through 2026 to control inflation, the interest rate differential between the US and Japan will remain high, and arbitrage trading will continue to be a persistent driver of yen depreciation.

Key data shows that although the US-Japan interest rate differential has narrowed, its absolute level remains large. This means that even if the Bank of Japan takes action, the USD/JPY still needs stronger policy signals to weaken significantly.

Intervention Expectations vs. Actual Actions, a Game in Progress

Interestingly, market concerns about Japanese government intervention may itself reduce the necessity for actual intervention. Jane Foley, head of foreign exchange strategy at Rabobank, posed this paradox: if fears of intervention are enough to curb the upward momentum of USD/JPY, then authorities may have no real need to act. This suggests that the threat of government intervention may be more effective than actual intervention.

From a technical perspective, after the USD/JPY broke below the high of 156, short-term support and resistance levels will be key in determining the near-term trend. Volatility remains low, indicating that while the market is paying attention to the yen exchange rate, overall risk sentiment has not experienced significant fluctuations.

The Biggest Risk Lies in Expectation Mismatch

The Bank of Japan will announce its interest rate decision on December 19, while the Federal Reserve’s decision will be announced the week prior. Analysts point out that the BOJ’s decision will be highly dependent on the Fed’s actions. This “follow-the-leader” pattern means that December’s policy period is fraught with the risk of expectation reversals.

Investors should be cautious, as current market expectations for a rate hike by the Bank of Japan and a rate cut by the Federal Reserve may both be overly optimistic. Any unexpected policy move from either side could trigger a rapid reversal in USD/JPY, and the continued existence of arbitrage trading poses hidden risks. A narrowing interest rate differential does not mean the depreciation momentum has disappeared.