USD/JPY on the verge of a four-decade high following a hawkish Fed

USD/JPY Analysis

The Fed unanimously held rates unchanged at 3.5%-3.75% on Wednesday but struck an unequivocally hawkish tone. It raised its inflation forecasts and the median interest rate projection was bumped up to 3.8% from 3.4%, suggesting a hike this year, with the dot plot showing that half of participants expect higher rates ^[1]. New Chair Kevin Warsh, President Trump's pick, defied expectations for a potentially dovish tilt. Although he did not participate in the dot plot and refrained from providing clear forward guidance, he succinctly stated that the central bank "will deliver price stability" ^[2]. The outcome has bolstered Fed rate hike bets, with markets anticipating a move in autumn.

The Bank of Japan is already on a tightening cycle and did deliver another increase this week ^[3], but that has done little to assist the yen against the USDOLLAR. But fficials have stayed on a cautious tightening path, with one policymaker dissenting in favour of a hold, underscoring the timid approach. Moreover, policy remains accommodative with rates at just 1%, a vast differential with the Fed that sustains the favourable USD/JPY backdrop and the carry trade. The yen also falls victim to lingering concerns over Japan's public finances, eroding investor confidence amid broader currency debasement trends. After a record budget, the government announced additional spending of ¥3.1 trillion to mitigate the economic fallout from the Middle East conflict. ^[4]

On the geopolitical front, the US and Iran signed a Memorandum of Understanding that extends the ceasefire and reopens the Strait of Hormuz, though the two sides still need to negotiate stickier issues ^[5]. For now, Iran has only committed to toll-free safe passage for 60 days ^[6], meaning uncertainty over a lasting peace deal and the flow of energy could linger, allowing the greenback to continue benefiting from risk-off flows.

USD/JPY heads for another profitable week and is on the verge of a new four-decade high. The carry trade, geopolitical uncertainty and yen weakness all sustain a favourable backdrop for the pair abd the bullish bias. However, the upside is getting technically stretched and the surge raises the risk of FX intervention, leaving the pair vulnerable to volatility and pullbacks that could breach the EMA200 and challenge the upside momentum.

Japanese authorities spent ¥11,734.9 billion on FX intervention from late April to early May to support the yen ^[7]. Their interventions had sent the pair sharply lower even if they failed to make a lasting impact. With USD/JPY now near a four-decade peak, the risk of fresh action is rising and key officials have warned as much.

Moreover, the BoJ may have been raising rates slowly, but remains committed to additional tightening. The economy is showing remarkable resilience thanks to the AI boom lifting its semiconductor sector, which drove total exports up 17% in May - the highest in over three years ^[8]. Consumer inflation may have eased in recent months due to government support measures, but the BoJ raised its forecast in April, expecting CPI to stay well above the 2% target ^[9]. Cost pressures for businesses are mounting, with PPI rising 6.3% y/y in May, the fastest pace in more than three years, while real wages have been expanding for the past four months.