FX Weekly

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BoJ-Fed policy divergence weighs on USD/JPY

FX View:

The USD is on track to weaken for a second consecutive week, driven by growing market expectations that the Fed will deliver a third straight rate cut next week. The USD’s yield advantage has continued to erode. However, downside risks from a Fed rate cut already appear largely priced in. In fact, the USD could find support if the Fed pairs the cut with more hawkish rhetoric. We expect the Fed to signal that the pace of rate cuts will likely slow next year and become increasingly data-dependent. A more prolonged pause at the start of next year could help limit further downside for the USD. Meanwhile, the JPY has been buoyed by signals from the BoJ that it plans to resume rate hikes this month. Policymakers in Japan will be hoping that a BoJ rate hike alongside a Fed rate cut will help reverse the sharp weakening trend in the JPY. Otherwise, pressure will continue to build for another round of intervention to support the currency

USD WEAKENS FOR 2ND WEEK AHEAD OF FOMC MEETING

Source: Bloomberg, 14:45 GMT, 5th December 2025 (Weekly % Change vs. USD)

Trade Ideas:

We are closing our long EUR/GBP and short CAD/CHF trade recommendations.

Weekly Calendar:

There is busy schedule of G10 central bank policy meetings scheduled for the week ahead including: i) the RBA on Tuesday, ii) the BoC and Fed on Tuesday, and iii) the SNB on Thursday.

Short Term Regression Modelling:

Our BEER fair value model indicates that USD/JPY is trading above its estimated equilibrium, signalling that the pair is overstretched and expensive. Historically, short-term rate differentials have been the dominant driver of USD/JPY price action, but their influence has diminished recently confirming a structural shift in the currency’s dynamics.

FX Views

USD/JPY: Weighing up risks ahead of Fed & BoJ policy meetings

The USD is on track to weaken for a second consecutive week ahead of the Fed’s final policy meeting of 2025. After twice failing to break above the 100.00 level in November, the dollar index has retreated into the 96.000–100.00 trading range that has persisted since Q2. Recent price action suggests the USD continues to consolidate at weaker levels following the sharp sell-off in the first half of this year. The correction lower over the past couple of weeks has been driven by a dovish repricing of Fed rate expectations, with the U.S. rates market now almost fully pricing in a third consecutive rate cut in the week ahead.

There has been no strong pushback from Fed officials against rate-cut expectations since New York Fed President Williams stated on 21 November that he still “sees room for a further adjustment in the near term to the target range for the federal funds rate to move the stance of policy closer to the range of neutral.” His comments sent a strong signal that the Fed leadership remains inclined to deliver one final rate cut this year, encouraged by signs of a loosening labour market. However, the FOMC appears increasingly divided over the need for further easing. After Fed Governor Jeffrey Schmid voted to hold rates steady at the October meeting, it would not be surprising to see more dissents next week. Several officials, including Chicago Fed President Goolsbee and St. Louis Fed President Musalem, have indicated they favour leaving rates unchanged. But we are not expecting significant changes to the FOMC’s updated projections for the economy or the policy rate.

To push through a rate cut, Fed leadership may need to pair it with more hawkish guidance. We expect the updated communication to signal that the pace of rate cuts will likely slow next year, while emphasizing that the path remains highly data-dependent. A rate hike at the January FOMC meeting is already seen as unlikely by the U.S. rates market, and current pricing suggests roughly a 50:50 probability of another cut by March. By the January meeting, the Fed will have greater clarity on labour market conditions after the release of the November and December nonfarm payroll reports. More hawkish guidance next week could provide support for the USD and further delay expectations for another cut early next year. U.S. growth is expected to strengthen in the first half of next year, reflecting a rebound from the recent government shutdown and the impact of tax cuts included in the “One Big Beautiful Bill.” These factors could discourage additional rate cuts if they spill over into stronger labour market conditions.

YIELD SPREADS CONTINUING TO MOVE AGAINST USD

Source: Bloomberg, Macrobond & MUFG GMR

UNWIND OF JPY-FUNDED CARRY IS A RISK

Source: Bloomberg, Macrobond & MUFG GMR

In contrast, the JPY has rebounded since USD/JPY hit a high of 157.89 on 20 November, falling to a low of 154.35 earlier today. The stronger JPY has been driven by a hawkish repricing of BoJ rate hike expectations. A keynote speech from Governor Ueda on Monday signalled that the BoJ is planning to resume rate hikes as soon as this month. Media reports from Bloomberg and Reuters have since confirmed that a hike is likely unless a negative economic or market shock occurs before the next policy meeting on 19 December. The last major economic data release before that meeting will be the Q4 Tankan survey, scheduled for 14 December. Reports suggest the government will not block the BoJ from raising rates, easing concerns of pushback under new Prime Minister Takaichi, who favors reflationary policies to boost growth. These developments support our forecast for the BoJ to raise rates by 25bps this month and deliver further gradual tightening next year, with two additional 25bps hikes expected to lift the policy rate to 1.25%. This would bring the rate closer to the BoJ’s estimated neutral range of 1.00%–2.50%, although Governor Ueda emphasized this week that the precise location of the neutral rate remains highly uncertain.

Normally, a BoJ rate hike combined with guidance to continue gradual policy normalization would provide support for the JPY—especially at a time when the Fed is expected to keep cutting rates, narrowing yield differentials from both sides. The last time this sequence occurred was at the turn of the year: the Fed cut rates in December 2024, and the BoJ hiked in January 2025. USD/JPY peaked at 158.87 on 10 January, just before the BoJ meeting on 24 January, and then fell back to around 140.00 by April as the USD weakened sharply. Japanese policymakers will be hoping that the upcoming central bank meetings help reverse the sharp JPY sell-off triggered by Sanae Takaichi’s victory in the LDP leadership election in early October and her subsequent appointment as prime minister.

However, the current backdrop remains challenging for the JPY, limiting its upside. Firstly, market participants remain concerned about fiscal risks in Japan, which continue to weigh on the currency. Long-term JGB yields jumped again this week, reflecting not only BoJ rate hike expectations but also growing unease over rising fiscal risks. While these concerns are attracting more attention among domestic policymakers, it is still too early to expect the government to scale back spending plans. Finance Minister Katayama did emphasize, however, that “we are, of course, giving due consideration to fiscal sustainability in the budget drafting” for the next fiscal year. Secondly, FX market volatility is currently near year-to-date lows, which is supportive for JPY-funded carry trades and encourages JPY selling.

If the JPY continues to weaken after the Fed cuts rates and the BoJ hikes this month, pressure will mount on Japan to intervene in the FX market for the first time since July 2024, when USD/JPY was trading between 157.00 and 162.00. On that occasion, Japan intervened on 11 and 12 July to support the yen, ahead of the BoJ’s rate hike on 31 July. The combination of intervention and a BoJ hike triggered a sharp unwind of JPY-funded carry trades during the summer of 2024. The rebound was later reinforced by the Fed starting its easing cycle with a larger 50bps cut in September. This episode serves as a reminder of the risk that the JPY could strengthen sharply again if carry trades are unwound. Our short-term valuation models currently indicate that JPY weakness has significantly undershot normal fundamental drivers, increasing the risk of a bigger snapback if concerns over the policy shift underway in Japan under Prime Minister Sanae Takaichi begin to ease.

Weekly Calendar

Source: Bloomberg & MUFG GMR

Key Events:

• A busy week of G10 central bank meetings lies ahead, including: i) the RBA on Tuesday, ii) the BoC and Fed on Wednesday, and iii) the SNB on Thursday
• The Fed’s meeting will be the main event risk. We expect the Fed to deliver a third consecutive 25bps rate cut, though the decision is unlikely to be unanimous. Additional dissents to keep rates on hold are likely, joining Governor Schmid who opposed the October cut. We do not anticipate major changes to the Fed’s updated economic projections. The dot plot should continue to signal one or two more cuts in 2026 to bring the policy rate closer to the Fed’s neutral estimate. However, guidance may strike a more hawkish tone, indicating a preference to slow the pace of cuts early next year while emphasizing that policy remains highly data-dependent
• We are more confident the BoC and RBA will leave rates unchanged. In Canada, economic activity and inflation have surprised to the upside since the BoC’s October meeting, including strong rebounds in employment and GDP following summer weakness. The BoC previously signaled that the policy rate is at about the “right level” if inflation and growth evolve broadly as expected. Similarly, Australia’s labor market and inflation have both exceeded expectations since the RBA’s November meeting. The Australian rates market has even fully priced in a hike by the end of next year. While the RBA is likely to signal that further cuts in early 2026 are less likely, it would be surprising to see it talk up the prospect of hikes at this stage
• The SNB is also expected to hold rates steady. The SNB faces pressure to ease further given weak domestic fundamentals and a strong CHF. Switzerland’s economy contracted in Q3 (excluding large sporting events), and inflation has fallen close to 0%. However, the recent trade deal lowering U.S. tariffs on Swiss goods and the SNB’s reluctance to return to negative rates suggest policy will remain at the zero bound.