Yen Weakens Against Dollar Amid Fed Hawkish Rate Hike; BOJ Decision Looms

Following a hawkish interest rate hike by the U.S. Federal Reserve (Fed), the yen has reversed to weakness against the dollar, drawing market attention to Japan's central bank (BOJ) decision on interest rates and further tightening signals set for October 18.

According to Bloomberg, as of October 16 (local time), the yen fell as much as 1% against the dollar during the day, reaching 156.42 yen per dollar after the Fed's rate decision. The currency had shown strength earlier this month due to expectations of rapid BOJ tightening and unwinding of yen-based carry trades, but has now shifted back to weakness.

The Fed's first rate increase since 2023, coupled with warnings of further tightening, has weighed on the yen. Markets are pricing in a potential three additional rate hikes by mid-2024. Concerns are growing that even if the BOJ raises rates this week, the interest rate gap between the U.S. and Japan may persist for an extended period.

Market focus is shifting from whether the BOJ will raise rates to how quickly it might tighten further. The overnight index swap (OIS) market has already factored in a 0.25% rate hike, making Bank of Japan Governor Kazuo Ueda's post-decision signals on additional hikes critical.

Glen In at ACCM Research noted that the BOJ faces significant pressure to deliver hawkish messaging alongside rate increases to minimize yen weakness, warning that failure to meet market expectations could lead to a rapid decline toward 160 yen per dollar.

Recent oil price rises may also bolster arguments for further BOJ tightening. Maruyama Rinto of SMBC Nikko Securities explained that yen depreciation provides the BOJ with grounds to highlight inflation risks, while high oil prices could serve as justification for additional rate hikes.

However, with Japan's policy rate now entering the estimated neutral range following this rate hike, expectations for a 0.50% increase or consecutive tightening are limited. Maruyama predicted that if the meeting is perceived as dovish, the dollar-yen exchange rate could initially target 158 yen, though it may revisit the 160 yen level if U.S. rates continue to rise faster than Japan's.

Akira Moro of Aozora Bank also cautioned that a simple rate hike alone might not support the yen, suggesting further depreciation could resume if the BOJ does not adopt a hawkish stance like the Fed, with 158.50 yen per dollar identified as the next key level.

Notably, after recent sharp yen appreciation, carry traders have incurred losses and hedge funds have reduced their bets on yen weakness, potentially limiting further downside speed. Foreign exchange market intervention by U.S. or Japanese authorities is also seen as a factor that could curb rapid yen depreciation.