By Linh Tran, Market Analyst at XS.com
USDJPY has recorded a notable correction in recent sessions as it retreated from the recent peak around 157.8 to 154.9, marking a temporary weakening of the USD while reflecting new expectations regarding Japan’s monetary policy.
This decline does not stem from a single factor, but rather from a combination of stronger signals from the Bank of Japan (BoJ) and profit-taking from previous USD long positions. However, the current downturn still appears to be more of a correction than a long-term reversal, as the core economic foundations guiding the USDJPY trend still lean toward a stronger USD relative to the Yen.
The most important signal behind this decline comes from the BoJ as market expectations emerged that the institution may continue raising interest rates as early as December. According to Reuters, the Japanese government indicated that the cabinet is willing to accept another rate hike. This expectation alone was enough to temporarily unwind carry-trade positions using the Yen as a funding currency, creating support for a JPY rebound. The BoJ has also delivered “slightly hawkish” signals in recent speeches, emphasizing that inflation may remain higher than expected and therefore monetary policy needs to be reassessed. This further reinforces the short-term decline of USDJPY.
However, behind the policy narrative lies an economic reality that is not particularly favorable for Japan. Household spending data for October showed consumption falling 3.0% year-on-year and 3.5% month-on-month, marking the sharpest decline in nearly two years. This reflects still-weak domestic demand and indicates that much of Japan’s inflation does not stem from strong consumption but rather from rising import costs as the Yen weakens. Given this fragile consumption environment, the BoJ cannot implement an aggressive tightening cycle, as such action would place direct pressure on growth. Therefore, although the Yen may see short-term recovery on policy expectations, its ability to sustain strong gains over the long term remains limited.
In addition, the U.S. economy is showing some signs of cooling, putting pressure on the USD. Some recent employment data (ADP recorded a decline of 32K) and consumption indicators show that growth momentum is slowing, raising expectations that the Fed may cut rates as early as this December.
However, these figures only represent one dimension, and from a broader perspective the U.S. economy remains relatively resilient.
U.S. growth has not declined sharply, inflation is cooling but not quickly enough for the Fed to reverse policy aggressively, and instead markets must wait cautiously for the upcoming FOMC communications. The Fed has repeatedly emphasized that rate cuts in 2025 will be implemented cautiously and will depend on data. This means U.S. interest rates will remain relatively high, thereby continuing to provide solid support for the USD in the medium term.
The key factor overall still lies in the interest rate differential between the two economies, which has driven the prolonged upward trend of USDJPY over the past two years. Even if the BoJ continues to raise interest rates, Japan’s policy rate after the hike will still be only around 0.75%, far lower than the nearly 4% rate of the Fed. This substantial gap ensures that carry trades remain attractive, international capital continues to favor the USD, and therefore USDJPY is unlikely to fall deeply unless there is a major policy shift from both sides. This is also why, even though USDJPY dropped sharply to 154.9, this is still viewed as a healthy correction after an extended rally.
Overall, this adjustment reflects new policy expectations from the BoJ and temporary USD weakness as U.S. yields ease. However, factors such as the interest rate differential and the relative health of the U.S. economy have not changed sufficiently to reverse the long-term uptrend of USDJPY. This keeps the fundamental outlook tilted toward a stronger USD over JPY, even as the market is experiencing a short-term correction in USDJPY.
Unless there are unexpected signals from the Fed or a more decisive move from the BoJ than currently anticipated, the current declines in USDJPY, in my view, will continue to be seen as necessary technical corrections rather than clear signs of a trend reversal.
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