Bank of Japan's December decision imminent: Which way will the USD/JPY go?

The Federal Reserve is the “Hidden Hand”

The market’s focus is currently on the Bank of Japan’s interest rate decision on December 19. But the true determinant of the yen’s fate may not be the Bank of Japan itself.

Analysts point out that the Federal Reserve will announce its own interest rate decision one week before the Bank of Japan meeting. This means the Bank of Japan is likely to adjust its strategy based on the Fed’s stance. Simply put: if the Fed holds steady, the Bank of Japan will face significant upward pressure on interest rates; conversely, if the Fed begins to cut rates, the Bank of Japan will have more reason to delay rate hikes.

The latest market survey shows that investors’ expectations for the Bank of Japan to raise rates in December or January are nearly evenly split, both around 50%. Commonwealth Bank of Australia analyst Carol Kong believes that the cautious Bank of Japan may choose to “wait and see,” acting only after the parliament approves the budget. The advantage of this approach is to buy time for subsequent wage negotiations.

Can the USD/JPY sustain its high levels?

From an exchange rate perspective, recent developments have indeed shifted. As expectations for the Bank of Japan to raise rates increase and the Fed to cut rates strengthen, the interest rate differential between Japan and the US is narrowing. In this context, a correction of the USD/JPY from high levels has become highly probable. As of November 27, the USD/JPY briefly fell below the 156 level.

But how far can this adjustment go? The answer may be disappointing. UBS forex strategist Vassili Serebriakov notes that a single rate hike is far from enough to reverse the yen’s depreciation trend. Unless the Bank of Japan adopts a tough, sustained rate hike policy and publicly commits to continue raising rates in 2026 to combat inflation, the interest rate gap between Japan and the US will remain high, providing continuous momentum for arbitrage trades.

Additionally, volatility remains in a low range, further increasing the difficulty of a yen rebound.

Can government intervention rewrite the script?

On November 26, Japanese Prime Minister Sanae Sato warned that the government is closely monitoring exchange rate movements and is prepared to take necessary action in the foreign exchange market at any time. These remarks have sparked market speculation about the possibility of Japanese government intervention.

Jane Foley, head of FX strategy at Rabobank, offers an interesting perspective: if concerns about intervention are strong enough to suppress the upward momentum of USD/JPY, then the actual need for Japanese authorities to intervene may decrease. In other words, expectations themselves can become a self-fulfilling limiting factor.

Risks investors need to watch

The current market is in a delicate balance. The yen’s depreciation pressure has never truly disappeared, the US-Japan interest rate differential remains substantial, and arbitrage trades continue. But the possibility of government intervention and the uncertainty of central bank policies pose potential reverse volatility risks for USD/JPY.

Around the end of the year, regardless of the Fed’s decisions, investors need to closely monitor the Bank of Japan’s moves and actual government actions, as these factors will directly influence the medium-term trend of USD/JPY.