On Thursday, the U.S. dollar weakened after the Federal Reserve signaled the possibility of an interest rate cut in September. This development kept the yen near its highest level since March, following a hawkish shift by the Bank of Japan.
The previous day’s trading was eventful, with the Bank of Japan raising Japan’s interest rates to levels not seen in 15 years. This prompted traders to reevaluate popular carry trades before the Fed decided to hold rates steady but hinted at future cuts due to cooling U.S. inflation.
In early trading, the yen saw significant volatility, rising nearly 1% to 148.51 per dollar—its highest since mid-March—before settling at 149.95.
“BOJ normalization and a potential Fed rate cut represent a shift from Fed-BOJ policy divergence to convergence,” said Christopher Wong, currency strategist at OCBC. “Policy convergence should shift the direction of USD/JPY to the downside, although the risk is that the Fed may not follow through.”
The BOJ also announced plans to reduce its monthly Japanese government bond purchases by half starting in January-March 2026, with Governor Kazuo Ueda not ruling out another rate hike this year.
The yen surged by 7% in July, marking its strongest monthly performance since November 2022, following interventions by Japanese authorities totaling $36.8 billion. These interventions led to an unwinding of profitable carry trades, where traders borrow yen at low rates to invest in dollar-denominated assets for higher returns.
Despite this, the yen continues to be hampered by the significant interest rate gap between Japan and the U.S., down 5% against the dollar so far this year.
“The BOJ’s actions should help stabilize the yen, but much of the remaining yield differential will need to be addressed by the Fed,” said portfolio managers from AllianzGI’s Multi Asset team. “In the absence of Fed action, short positions on the yen may re-emerge.”
CFTC data shows that bearish bets against the yen are 40% below April’s near-seven-year high but remain elevated at $8.61 billion.
The dollar index, which measures the U.S. currency against six peers, was at 104.03, having dropped 0.38% on Wednesday. It fell 1.7% in July, its weakest monthly performance of the year.
The euro stood at $1.082875 after rising 1% in July, while sterling remained steady at $1.28485 ahead of the Bank of England’s policy decision, where a rate cut is possible but uncertainty remains.
Dovish Fed
With the Fed remaining data-dependent, investor attention is focused on Friday’s government jobs report for July, expected to show 175,000 new jobs added, according to economists surveyed by Reuters. The July inflation report, due on August 14, will also be a key data point.
Markets have long anticipated a 25 basis points rate cut in September and have increased bets on a more substantial reduction, even after Fed Chair Jerome Powell stated that a 50-basis-point cut is not being considered “right now.” Traders are now expecting 72 basis points of easing this year.
“Markets have been anticipating more rate cuts than what the Fed’s June dot plot suggested before yesterday’s announcement. Chair Powell did not seem to oppose this view,” said Charu Chanana, head of currency strategy at Saxo. “This has heightened expectations for larger rate cuts, which will be heavily influenced by the economic outlook.”
In other currencies, the Australian dollar fell 0.11% to $0.6529 after dropping 2% in July, while the New Zealand dollar was last at $0.5951.
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