A former Bank of Japan deputy governor, Hiroshi Nakaso, has suggested that interest rate hikes could resume to better match the economy and inflation with expectations. However, the Bank of Japan (BOJ) needs to be careful about potential inflation risks, especially if rising food prices continue to drive inflation expectations higher. While the dollar is likely to remain the primary global currency, there are signs that other currencies are gaining traction. This change is driven by external factors like tariffs that are reshaping the global economic landscape.

Possible Interest Rate Hikes

Nakaso’s comments indicate that the Bank of Japan may be preparing for another interest rate hike. This move would aim to strengthen the yen and show that the BOJ is managing the economy effectively. For those trading derivatives, it’s a signal to consider put options on the USD/JPY pair, betting on a stronger yen. His concerns about rising inflation are backed by recent data. Japan’s core inflation rate, which excludes fresh food, reached 2.5% in May 2024, staying above the central bank’s 2% target for the 26th month in a row. This ongoing inflation pressure makes an interest rate increase at the July or September meetings highly likely, supporting a bearish outlook for USD/JPY. The idea that there are cracks in the dollar’s dominance aligns with a broader trend we are observing. Although the U.S. dollar index (DXY) has been strong, recently hitting a high of 106, central banks around the world have been slowly decreasing their dollar reserves in favor of other assets. This long-term diversification could cap the strength of the dollar, making a stronger yen more realistic.

Market Volatility and Strategic Approaches

We also need to consider the “Trump tariff” scenario, which brings significant uncertainty. Proposed wide-ranging tariffs might push investors toward the dollar as a safe haven, temporarily increasing the USD/JPY pair and countering our strategy. This mixed outlook signals high volatility, so strategies like options straddles on the currency pair may be wise to capture large moves in either direction. Looking back at the last rate hike in March offers important insights. After that announcement, the yen weakened because the central bank’s guidance was seen as too lenient. For a stronger yen this time, traders will need to hear not just about a rate hike but also strong, hawkish statements from the bank. Create your live VT Markets account and start trading now.

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