Federal Reserve’s Decision-Making Challenge

The USD/JPY pair is slightly down, trading around 151.90 during early Thursday’s Asian session. Worries about the US-China trade situation and the ongoing US government shutdown are affecting the US Dollar’s value against the Japanese Yen. The US government shutdown is now in its fourth week, with no end in sight. The Senate plans another vote on a funding bill, but it is expected to fail. This shutdown is now the second longest in US history. The release of important US economic data has stopped, making it harder for the Federal Reserve to make decisions. The Fed is expected to cut its key interest rate by 25 basis points on October 29 and again in December, which could weaken the Greenback against the JPY. Japan’s new Prime Minister, Sanae Takaichi, is preparing a stimulus package expected to exceed last year’s $92 billion. Traders believe that this expansionary fiscal policy will affect the currency. Several factors influence the Japanese Yen, such as the Bank of Japan’s policies, the difference in bond yields between Japan and the US, and market risk sentiment. The Bank of Japan controls currency, and previous interventions have often lowered the Yen’s value. For the past ten years, Japan’s very loose monetary policy has helped support the USD against the JPY.

Volatility in USD/JPY Options

The ongoing US government shutdown, now in its fourth week, is creating uncertainty and putting pressure on the US dollar. Analysts estimate that this paralysis could reduce fourth-quarter GDP by about 0.2% for each week it continues. This political deadlock and its economic impact are pressing down on the USD/JPY pair. The Federal Reserve is effectively operating without key economic data from the Bureau of Labor Statistics and the Census Bureau. Markets are currently pricing in a 92% chance of a 25 basis point rate cut on October 29, according to the CME FedWatch Tool. This strong expectation for a more lenient monetary policy is likely to limit any significant dollar rally in the next few weeks. Meanwhile, we are following Japan’s new Prime Minister, who is preparing a large fiscal stimulus package estimated at around ¥15 trillion. This type of expansionary spending, similar to what we saw in early 2020, will likely put pressure on the Japanese Yen over time. This could stop the Yen from gaining significantly and provide a support level for the USD/JPY pair. Due to the political uncertainty and lack of US economic data, implied volatility in USD/JPY options has increased. The 1-month volatility index for the pair has risen from 8.5% to 10.2% in the past two weeks, indicating trader anxiety. In this environment, strategies that benefit from price swings, like buying straddles or strangles before the Fed’s decision on October 29, could be appealing. For traders with a specific viewpoint, the combination of a dovish Fed and shutdown worries suggests a bearish outlook for the dollar. Purchasing USD/JPY put options with expirations in late November offers a defined-risk way to prepare for a potential drop below the 151.00 support level. Looking back at the extended government shutdown from 2018 to 2019, we observed a similar trend of dollar weakness that ultimately benefited the yen. Create your live VT Markets account and start trading now.

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