The yen broke through the key psychological level of 140 against the dollar, extending its gains since hitting a near 38-year low in July. On Monday, the yen appreciated as much as 0.6% to 139.96 against the dollar, its highest level since July 2023. The yen has been the best performing G10 currency this quarter, rising 15% as investors expect the interest rate gap between the United States and Japan to narrow further.

The Federal Reserve seems almost certain to cut interest rates this week, the only question being by how much, while the Bank of Japan is expected to hold off on policy on Friday after raising rates twice this year. With liquidity reduced over the holidays, bets have been renewed that the U.S. will cut rates by a bigger margin than usual, sending the Bloomberg Dollar Strength Index to its lowest level since January.

“It’s mainly the Fed countdown and the risk that they might cut rates by 50 basis points this week instead of 25 basis points that’s supporting the yen,” said Gareth Berry, a strategist at Macquarie Group in Singapore. “Even if expectations for Fed easing haven’t changed, the passage of time alone will push USD/JPY lower.”

The yen’s fortunes have changed dramatically since hitting a low of 161.95 on July 3. Japan has intervened repeatedly to prop up the currency, but now it’s rising too fast, hurting the outlook for exporters and, in turn, Tokyo stocks.

While the Bank of Japan may not change borrowing costs this week, most economists surveyed by Bloomberg believe the bank will raise rates again in December. The Bank of Japan raised its policy rate to 0.25% on July 31, causing turmoil in global markets in early August, hitting assets ranging from currencies to bonds and stocks. On September 3, Bank of Japan Governor Kazuo Ueda confirmed that the central bank would raise interest rates if prices meet expectations, supporting the yen's rebound.

The central bank will continue to adjust policy if the economy performs in line with its forecasts, board member Junko Nakagawa said in comments on Sept. 11.

In addition to the Bank of Japan’s policy, the yen’s appreciation has also been driven by the rapid unwinding of so-called carry trades, where traders borrow yen cheaply and invest the proceeds in higher-yielding currencies. Many strategists have abandoned their earlier forecasts for a weaker yen and expect it to move higher from here.

In early July, when the yen hit a multi-decade low, some warned that even Japanese intervention would not stop the slide, with bears predicting a fall below 170 yen per dollar. Richard Franulovich, head of currency strategy at Westpac Bank in Sydney, said, "USD/JPY is likely to continue to move lower over the next one to three months, perhaps between 137 and 138. A dovish Fed and a hawkish Bank of Japan are admittedly priced in, but reality may also have an impact."

"We believe that the Fed is about to embark on a new easing cycle, which is a major headwind for the dollar," said Rodrigo Catril, a strategist at National Australia Bank. "As the Fed eases monetary policy next year and lowers the funds rate to neutral or even below neutral, the dollar will begin a cyclical decline."

However, a technical indicator showed the dollar would find support as momentum turned bearish.“While there is a risk of an early start to the Fed’s easing cycle, we think the market has overestimated this risk and a 25 basis point rate cut by the Fed this week would drive a rebound in the dollar,” said David Forrester, a strategist at Credit Agricole in Singapore.

Still, markets are overwhelmingly in favor of a weaker dollar. Analysts surveyed by Bloomberg are expected to see the euro, yen, Canadian dollar and Australian dollar all strengthen against the greenback by this time next year. “An unexpectedly dovish Fed could weaken the dollar,” Bob Savage, head of market strategy and insights at the New York bank, wrote in a note. That could “alter inflation forecasts for countries like the U.K. that import dollar-denominated commodities and prompt Norway’s central bank to support the oil-pegged krona,” he wrote.

The article is forwarded from: Jinshi Data