The USD/JPY pair climbed to about 154.05 in early Asian trading after US private payrolls increased by 42,000 in October. This rise was more than expected and followed a drop of 29,000 in September. Additionally, the ISM reported that activity in the US services sector grew, with its PMI reaching 52.4 in October. These economic updates have sparked talks of another interest rate cut by the Federal Reserve, which is supporting the US dollar against the yen.

Bank of Japan’s Rate Hike Possibilities

The minutes from the Bank of Japan’s September meeting show that some members are starting to support possible rate hikes, though there are still worries due to Japan’s history of deflation. Comments from Japanese officials also back the yen, as they try to maintain exchange rate stability. The value of the yen is influenced by Japan’s economic performance and the difference in bond yields between Japan and the US. General market sentiment affects the yen too, as it is seen as a safe-haven currency during uncertain times, which can enhance its value. The Bank of Japan’s shift away from very loose monetary policy is narrowing the bond yield gap, affecting how the yen performs against the dollar. With the US dollar’s strength pushing USD/JPY over 154, we expect the upward trend to continue. Better-than-expected US payroll and services data make a Federal Reserve rate cut this year seem unlikely. This solid foundation for the dollar should keep the pair in demand in the short term.

Implications of US Inflation Data

Recent US inflation for October was at 2.8%, reinforcing the idea that the Fed will keep rates unchanged. Futures markets are now showing less than a 15% chance of a rate cut before the year ends, down from over 40% last month. This difference in policy is a major reason for the dollar’s strength against the yen. Meanwhile, the Bank of Japan is hinting at a possible rate hike, but action is slow due to its long-standing fears of deflation. The interest rate gap between the US and Japan is crucial, with the difference between US 10-year Treasuries and Japanese government bonds around 370 basis points. This makes borrowing yen to buy dollars an appealing trade for institutions. We should remain cautious, as Japanese officials are already giving verbal warnings, often signaling potential action. In the fall of 2022, the Ministry of Finance intervened to buy yen when the rate topped 151.90. Since the current level is much higher, the risk of sudden intervention is increasing daily. Given this situation, buying USD/JPY call options could be a smart way to capture further gains while minimizing the risk from possible intervention. This allows us to benefit if the pair rises towards 155 or more, with our potential loss capped at the premium paid if the Ministry of Finance intervenes. Selling out-of-the-money puts could also finance these calls, but this comes with considerable risk if the pair moves sharply in the opposite direction. Create your live VT Markets account and start trading now.

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