Key points:
The dollar weakened further on Monday, reaching 139.915 yen as investors grew increasingly confident that the Federal Reserve might implement a larger-than-expected rate cut later this week.
This recent dip marks a continuation of the dollar’s retreat from 140.285 yen, a level last seen in December 2022.
SEE: USDJPY displays prominent downward trend as observed on the VT Markets app.
The USDJPY pair has seen a persistent downward trend, closing at 139.91 after opening the day at 140.77. The MACD (12,26,9) histogram has shown sustained bearish momentum, with selling pressure evident across recent sessions.
This decline is representative of growing speculation around the Federal Reserve’s upcoming meeting on September 17-18. Traders remain divided on whether the Fed will pursue a 25-basis-point cut or a larger 50-basis-point reduction. The 50-basis-point cut, though a minority view, has seen renewed attention amidst soft economic data in the U.S.
Futures markets currently suggest a 60% chance of a 50 bps cut, up from just 15% last week, as investors react to recent data releases and comments from Fed officials.
Back to the chart, technically, the 139.57 level may act as immediate support, but further downside risks are apparent, especially if market sentiment tilts towards a more aggressive rate cut.
Also see: Traders bet on Fed’s next move, weakening the dollar
The U.S. dollar index (DXY), which tracks the dollar’s performance against a basket of six major currencies, slipped by 0.3% to 100.69, reflecting the broader weakening of the greenback.
The anticipation of a Fed rate cut has also pushed Treasury yields lower, with the 10-year benchmark yields down 30 basis points in just two weeks, while the two-year yields, which are more closely tied to Fed rate expectations, dropped to 3.55% from 3.94% over the same period.
Selling the dollar for yen has become a popular strategy for traders, especially with falling Treasury yields making the yen more attractive. The narrowing interest rate gap between the U.S. and Japan has fueled this move, especially as the Bank of Japan (BOJ) is expected to maintain its short-term policy rate at 0.25%.
Market participants are keenly watching Friday’s BOJ decision, as the yen’s strength could intensify if the Fed opts for a larger rate cut.
Yen-funded carry trades, which have seen billions of dollars unwound in recent weeks, have been another contributing factor to the yen’s rise.
With Japan raising rates twice already this year, traders are increasingly favouring the yen over the dollar, particularly as the U.S. is expected to adopt more dovish monetary policies moving forward.
The Bank of England is also in focus this week, with its policy decision due on Thursday. The central bank is expected to maintain its key interest rate at 5%, following a 25-bps cut in August, marking the beginning of its easing cycle.
The outcome will be closely watched, especially as other major central banks, like the European Central Bank (ECB), have signaled a pause in their rate cut cycles.
The euro edged up 0.4% to $1.1114, reflecting the market’s response to the ECB’s recent 25 bps rate cut. However, expectations for further cuts have been tempered by comments from ECB President Christine Lagarde.
The market will be listening closely to speeches from ECB officials Philip Lane and Luis de Guindos on Monday to gauge the ECB’s future moves.
The British pound also rose 0.4%, trading at $1.3170. In Canada, Bank of Canada Governor Tiff Macklem has hinted at increasing the pace of rate cuts after maintaining its key rate at 5% for a year.
The BoC has already implemented three 25-bps rate cuts since June, and further reductions could be on the horizon.
Looking ahead, much depends on the Federal Reserve’s decision later this week. A larger 50 bps cut could further weaken the dollar, especially against the yen and euro, as the interest rate gap continues to narrow.
On the other hand, if the Fed opts for a smaller 25 bps cut, the market may see a temporary stabilisation in the dollar’s decline. For now, selling the dollar for yen remains a favourable trade, and the prospect of higher Japanese rates will likely maintain this trend in the near term.
However, any surprises from the BOJ or ECB could lead to sudden shifts in currency pairs.
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