The night before the Federal Reserve decision: Japan's interest rate decision faces a crossroads

The Japanese exchange rate market has recently experienced intense volatility, with the USD/JPY rapidly falling from high levels to below 156. Driven by a combination of the Japanese authorities adopting a more hawkish stance and rising expectations of interest rate hikes, the long-term depreciation trend of the yen has temporarily paused, but the future direction remains uncertain.

Policy Signal Shift: Japan’s Authorities Turn Hawkish

In late November, Japanese government officials publicly stated that they would strengthen monitoring of exchange rate fluctuations and indicated readiness to take appropriate measures for market intervention at any time. This statement quickly heightened market alertness, prompting market participants to reassess the potential policy direction of the Bank of Japan.

According to informed sources, the Bank of Japan is fully preparing for a possible rate hike as early as December. As hawkish expectations intensify, the USD/JPY exchange rate has responded with a correction, and market sentiment has shifted noticeably.

Who Really Decides Japan’s Interest Rate Policy: The Federal Reserve

The upcoming Bank of Japan interest rate decision on December 19 has attracted much attention, but some analysts point out that the actual outcome of this decision may be influenced by the decision announced by the Federal Reserve a week earlier.

This creates a subtle policy game: if the Fed maintains interest rates, the pressure on the Bank of Japan to hike will significantly increase; conversely, if the Fed chooses to cut rates, the BOJ will have more room to delay its rate hike decision.

Current market surveys show that traders assign roughly a 50% probability to rate hikes in December and January. A strategist from a major Australian financial institution believes that the cautious approach of the Bank of Japan may lead it to wait until the parliamentary budget passes before acting, allowing more time to observe wage negotiations and avoiding hasty decisions.

Exchange Rate Outlook: Appreciating or Falling Back into a Depreciation Quagmire

From the perspective of interest rate differentials, expectations of BOJ rate hikes are rising while expectations of Fed rate cuts are also increasing. Under the combined influence, the US-Japan interest rate spread is expected to continue narrowing, laying the foundation for USD/JPY to decline from high levels.

However, pessimistic voices are also heard. Due to the still significant interest rate differential between the US and Japan, arbitrage mechanisms remain in operation, and the fundamental pressure for yen depreciation has never truly dissipated.

A foreign exchange strategist from a top Swiss investment bank warns that a single rate hike alone is unlikely to fundamentally reverse the yen’s trend unless the BOJ adopts a more aggressive rate hike path and explicitly commits to continued tightening through 2026 to curb inflation. The analyst also notes, “The US-Japan interest rate spread remains relatively high, and market volatility is still low, which limits the space for rapid yen appreciation.”

An FX chief from an international bank in the Netherlands offers another perspective: the market’s expectation of government intervention may have a greater impact than actual intervention. If concerns about intervention are sufficient to suppress further USD/JPY gains, authorities might not need to intervene directly, as the goal would already be achieved.

Market at a Critical Juncture

As December approaches, the Bank of Japan’s interest rate decision and the Federal Reserve’s policy meeting will take place in succession, with market participants closely monitoring these two major events. Whether the yen can halt its depreciation and begin an appreciation cycle depends not only on the boldness of the BOJ but also on the Fed’s policy trajectory and the flow of international arbitrage capital. In the short term, maintaining a cautious wait-and-see attitude is likely the most reasonable approach.