The widening US-Japan interest rate differential pushes up the dollar, can the yen hold the 156 level? [Forex Weekly Report]

Last Week’s Market Summary: Non-USD Currencies Diverge, Yen Hits New Weekly Low

Last week, the foreign exchange market showed a clear strong dollar trend. The US Dollar Index rose by 0.33%, continuing to strengthen amid diverging monetary policies among various central banks. Non-USD currencies performed unevenly: the euro declined by 0.23%, the Australian dollar fell by 0.65%, the British pound remained nearly flat with a 0.03% increase, while the yen was the biggest loser, dropping 1.28% for the week, with USD/JPY approaching the 158 level.

European Central Bank Stands Pat, Subtle Changes in Fed Rate Cut Expectations

The ECB kept its policy rates unchanged, in line with market expectations, but President Lagarde’s comments failed to deliver the hawkish signals previously anticipated by the market, leaving bullish traders somewhat disappointed.

US economic data showed complexity. Non-farm payrolls in November were mixed, and CPI growth was below expectations, which should have favored rate cut expectations. However, large investment banks like Morgan Stanley and Barclays pointed out that these data are heavily influenced by technical factors and seasonal adjustments, making it difficult to accurately reflect the true economic trajectory.

The bond market now prices in a 66.5% probability of the Fed cutting rates twice by 2026, with a 4月 rate cut priced in. However, this outlook remains uncertain. Danske Bank believes that due to the ECB maintaining easing policies and the Fed gradually entering a rate-cut cycle, the US-EU real interest rate differential will narrow, supporting the euro’s medium-term appreciation. The bank also notes that the recovery in European assets and uncertainties about US financial institutions’ confidence could be favorable factors for the euro.

Technical Outlook: EUR/USD remains above several key moving averages. Short-term, there is potential to test the previous high near 1.18, while a pullback could find support around the 100-day moving average at 1.165. This week, attention should be paid to the release of US Q3 GDP data; higher-than-expected growth will strengthen the dollar, while a weaker figure could support a euro rebound.

Bank of Japan’s “Moderate Rate Hike” Fails to Halt Yen Depreciation, Intervention Window Approaching

Last week, USD/JPY surged 1.28%, approaching the 158 level, reflecting market reactions to the BOJ’s latest policy move. The BOJ raised rates by 25 basis points as expected, but Governor Ueda’s comments were somewhat dovish, indicating limited policy tightening. More critically, Japan’s new government approved a fiscal stimulus package worth 18.3 trillion yen, which effectively offset the tightening effect of the rate hike.

Market expectations currently suggest the BOJ will implement only one rate cut by 2026, with the next rate hike possibly not until October 2026. Sumitomo Mitsui Banking Corporation believes that during this extended easing cycle, the yen could depreciate to 162 against the dollar in Q1 2026.

However, JPMorgan issued a warning. The bank stated that if the yen’s depreciation exceeds the 160 level in the short term, it would be classified as “sharp exchange rate fluctuations” by regulators, increasing the likelihood of direct intervention by the Japanese government. This aligns with authorities’ concerns about exchange rate stability. In contrast, Nomura Securities holds a more optimistic view, believing that under the global context of the Fed starting a rate cut cycle, the long-term weakening trend of the dollar is unlikely to change, and the yen could appreciate to around 155 in Q1 2026.

Yen-RMB Exchange Rate Correlation: The continued depreciation of the yen will also pressure the RMB exchange rate. When the yen weakens against the dollar, other Asian currencies, including the RMB, may also face depreciation pressures to maintain competitiveness. The USD/JPY exchange rate often reflects relative changes in monetary policies and economic fundamentals across the Asia-Pacific region.

Technical Analysis: USD/JPY has successfully broken below the 21-day moving average, with the MACD indicator signaling a clear buy signal, indicating short-term momentum remains strong. A break above 158 could open further upside space. Conversely, if prices remain under pressure below 158, the probability of a correction to support at 154 increases. This week, focus should be on Governor Ueda’s comments and whether Japanese authorities escalate verbal interventions; any hawkish signals could trigger a rapid adjustment in USD/JPY.