FOMC decision imminent, euro outlook and forex market landscape face restructuring [Forex Weekly Review]

Last Week Market Overview

In the past week (12/1-12/5), non-USD currencies performed strongly. The US Dollar Index declined by 0.50%, among major currencies, the Euro rose by 0.36%, the Japanese Yen appreciated by 0.53%, the Australian Dollar had the largest gain of 1.36%, and the British Pound increased by 0.74%.

1. Yen Appreciation Expectations Rise, but Gains Limited by Interest Rate Differentials

This week’s focus is on the Bank of Japan’s policy stance. Last week, USD/JPY fell by 0.53%, reflecting a significant increase in market expectations for Japanese rate hikes. According to Reuters, the Japanese government has indicated it will allow the Bank of Japan to raise interest rates, coupled with hawkish signals from Governor Ueda Kazuo. Currently, the market prices in a 90% chance of a rate hike in December.

However, interestingly, despite the rising probability of rate hikes, the actual appreciation of the Yen has not been as strong as expected, with USD/JPY still hovering around 155. Experts suggest this reflects the market’s perception that the real long-term interest rate differential between the US and Japan (interest rate difference after deducting CPI) is unlikely to narrow significantly.

In Japan, under the expansionary fiscal policies of Prime Minister Fumio Kishida, inflation expectations are expected to persist; meanwhile, the market anticipates only one rate hike by the Bank of Japan in 2026. In the US, the Fed’s rate cut cycle is expected to be relatively accommodative. This structural interest rate environment limits the Yen’s upside potential.

Institutional views on the medium-term trend of the Yen vary significantly. Mizuho Securities expects USD/JPY to reach 158 by the end of 2026, while Nomura Securities is more conservative, expecting a level of 140.

Technical analysis shows that USD/JPY has broken below the 21-day moving average. If it continues to stay below this level, the probability of further decline increases, with support around 153. Conversely, if it reclaims above the 21-day moving average, the likelihood of a rebound and upward oscillation increases, with resistance around 157.

2. The December FOMC Decision is Key, Euro Outlook Depends on Powell’s Tone

The US dollar remains under pressure mainly due to rising expectations of a rate cut by the Federal Reserve. Last week, EUR/USD rose by 0.36%, driven by this dollar weakness.

Market data supports this view from several angles. US November ADP employment data unexpectedly declined, with employment decreasing by 32,000 jobs, marking the largest monthly drop since March 2023. Meanwhile, the September PCE Price Index showed signs of easing inflation pressures, leaving room for the Fed to consider a rate cut in December.

According to the latest data from the CME FedWatch Tool, the market currently prices in an 87.2% probability of a 25 basis point rate cut at the December 10 meeting, with expectations of two more cuts by 2026.

Market focus has shifted to the Fed’s forward guidance. Key points to watch include: the December dot plot’s implications for the number of rate cuts in 2026, policy adjustments regarding bond purchases, and Chairman Powell’s tone in speeches.

If the December dot plot indicates more than two rate cuts in 2026, or if the Fed announces an unexpectedly large bond purchase program, the market will interpret this as dovish, further weakening the dollar, and the euro will likely strengthen, supporting EUR/USD gains. Conversely, if the dot plot suggests only one rate cut in 2026 and Powell’s language remains hawkish, the market will see this as a hawkish stance, supporting the dollar, and EUR/USD may face downward pressure.

On the technical side, EUR/USD has broken above the 100-day moving average, with RSI continuing to tilt upward, indicating bullish momentum. Supported by technical signals, EUR/USD is expected to rise further, with resistance levels at 1.18 and the previous high of 1.1918. If it pulls back after a rally, support levels are at the 21-day moving average of 1.1593 and the previous low of 1.1491.

This Week’s Trading Focus

This week’s key events are the Federal Reserve’s interest rate decision and developments in Russia-Ukraine peace talks. Since the market generally believes that the European Central Bank is nearing the end of its rate hike cycle, the Fed’s policy path for 2026 will be crucial in shaping EUR/USD trading. The relative strength of the Bank of Japan’s rate hike decision and the Fed’s stance will directly influence USD/JPY movement. Traders should closely monitor Powell’s remarks during the press conference and the market’s re-pricing of US-Japan interest rate differentials.