Will the Federal Reserve's policy steering and Japan's gold and yen appreciation dreams come true?

The concerns over the December rate hike by the Bank of Japan are influencing the outlook for the Japanese yen. As policy interactions become more complex, the yen exchange rate is facing a new turning point.

The “Pong” Effect of Rate Hikes by the BOJ and FOMC Decisions

On December 19, the Bank of Japan will announce a new interest rate decision, but market focus is directed toward the Federal Reserve’s actions a week earlier. Analysts point out that these two meetings create a subtle policy interaction—the Fed’s stance will directly impact the BOJ’s determination to raise rates.

If the Fed chooses to hold steady and maintain rates, the BOJ will face greater pressure to hike. Conversely, if the Fed initiates rate cuts, the BOJ is more likely to adopt a wait-and-see approach. Currently, market expectations for rate hikes by the BOJ in December and January are each about 50%, reflecting high uncertainty in decision-making.

ANZ Bank analyst Carol Kong offers an interesting perspective: “The BOJ has always been cautious and may wait until the parliament approves the budget before raising rates. This approach allows more time to study the developments in wage negotiations.”

The Real Driver of Yen Movements: The US-Japan Interest Rate Differential

Recently, USD/JPY fell below the high of 156, which the market attributes to rising rate hike expectations and the prospect of Fed rate cuts. But the fundamental reason lies in the continued narrowing of the US-Japan interest rate differential.

However, this narrowing may only be a short-term phenomenon. Vassili Serebriakov, a foreign exchange strategist at UBS, emphasizes: “The interest rate differential between the US and Japan remains wide, and arbitrage trading continues. A single rate hike cannot fundamentally reverse the long-term depreciation trend of the yen unless the BOJ adopts a hawkish stance and commits to continued rate hikes through 2026 to combat inflation.”

This view reveals the intrinsic link between Japan’s gold and the yen—the trend in the interest rate differential determines capital flows, which in turn influence the relative value of the yen.

Hidden Chips in Government Intervention

On November 26, Japanese Prime Minister Sanae Sato’s statements highlighted the government’s cautious attitude. The government will closely monitor exchange rate fluctuations and is prepared to take “necessary measures” in the foreign exchange market. This statement instantly changed market sentiment, and USD/JPY retreated accordingly.

Jane Foley, head of FX strategy at Rabobank, points out a paradox: “If the market is overly worried about intervention, it may actually self-restrain the dollar’s rally, thereby reducing the need for actual intervention.”

Will the Yen Appreciate or Will Arbitrage Continue?

In the short term, expectations of rate hikes and policy support provide a basis for the yen to rise. However, from a medium-term perspective, the upside for the yen is limited. The US-Japan interest rate differential remains high, and volatility is low, creating conditions that sustain the attractiveness of arbitrage trading.

The BOJ faces a dilemma: rapid and aggressive rate hikes could impact economic growth, while moderate hikes are unlikely to fundamentally change the yen’s predicament. The market will remain in a wait-and-see mode until the December decision reveals the truth.