BoJ & Fed policies set to diverge this month weighing on USD/JPY

USD: Soft US data reinforces Fed rate cut expectations and weaker US dollar

The US dollar has continued to trade at weaker levels overnight after yesterday’s sell-off. The dollar index fell back below the 99.000-level for the first time since late October. The main beneficiaries from the weaker US dollar in recent days have been the high beta G10 currencies of the pound, Norwegian krone, Australian and New Zealand dollars. The pound has continued to recover lost ground after the last week’s UK Budget failed to provide a negative shock for the gilt market. It has encouraged a lightening of short pound positions as the fiscal and political risk premium priced into the pound has eased in the near-term. Implied pound volatility has dropped sharply reflecting less investor concern over a sharper sell-off now the Budget has passed. The release yesterday of the final reading for the UK services PMI survey for November also showed some improvement in business sentiment as the drop in confidence was less than initially reported.

The broader US dollar sell-off that helped to lift cable back above resistance from the 200-day moving average at around 1.3325, was encouraged by lower US yields. Market expectations for the Fed to cut rates this month were reinforced by the release of softer US economic data yesterday. The latest ADP survey estimated that private employment contracted by -32k in November following an estimated increase of +47k in October. It has supports our view that labour demand remains weak heading into year end. With the release of the nonfarm payrolls report for November delayed until after the December FOMC meeting when it is scheduled to be released on 16th December, FOMC participants will have to rely more on alternative measures of labour market health to assess whether to cut rates this month. At the same time, the release of the ISM services survey for November should help to ease concerns over the inflationary impact of higher tariffs on imported goods spilling over into higher prices in the service sector. The prices paid sub-component dropped back sharply by 4.6 points to 65.4 in November. It was the lowest reading since April 2025 and follows an average reading of 69.6 in the previous four months. 

EUR/GBP VS SHORT-TERM IMPLIED VOLATILITY

Source: Bloomberg, Macrobond & MUFG GMR

JPY: BoJ rate hike expectations continue to build supporting the yen

The weaker US dollar and drop in US yields has helped to lower USD/JPY back below the 155.00-level overnight. Japanese policymakers will be hoping that building market expectations for a Fed rate cut alongside the BoJ resuming rate hikes this month will provide more support for the yen, and bring an end to the sharp yen weakening trend that has been in place since early October. Market expectations for a BoJ rate hike this month were fuelled by the hawkish signal from Governor Ueda at the start of this week. Those expectations have been supported as well by the a Reuters report overnight stating that the BoJ is likely to raise rates this month with the government expected to tolerate such a decision according to three government sources familiar with the deliberations. One of the government sources was quoted saying ”if the BoJ wants to raise rates this month, please make your own decision. That’s the government’s stance”. The comments add to our view that the BoJ has been given the green light from the government to raise rates, and will not sand in their way.

Governor Ueda spoke again overnight in parliament and put forward the view that the current policy rate remains accommodative. However, he was less clear over where the neutral policy rate in Japan. He stated ”unfortunately, it remains a concept that can only be estimated within a fairly wide range at present. We don’t know where it lies, but how much interest rates, nominal ones, will ultimately rise and how much will be appropriate will depend on that”. The BoJ has previously estimated that the nominal neutral policy rate could be in a range between 1.00% and 2.50% indicating there is still some room for further hikes in the coming years. We are currently pencilling (click here) in three more BoJ hikes by the end of next year that would lift the policy rate up to 1.25%. The rise in short-term yields this week has contributed to yields at the long end of the JGB curve moving higher as well. The 30-year JGB yield hit a fresh high of 3.45% overnight but has since dropped back by around 4bps after the latest 30-year auction revealed strong demand at higher yields. The bid-to-cover jumped to 4.04 reflecting the strongest demand since 2019.

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com