USD/JPY Sensitivity to US Data, Rate Cut Hopes

USD/JPY Talking Points:  

• It’s been a fast turn for the Yen today after an early sell-off was quickly erased following this morning’s PPI report.
• If we are nearing rate cuts from the Fed and if the bank is going in the direction that Treasury Secretary Scott Bessent spoke of yesterday, there could be fast unwind of carry trades, which could carry repercussions across markets.
• The PPI print this morning suggests the Fed may want to be cautious given recent inflation trends and markets have pared back the expectation for a September cut very slightly, but the reaction in JPY-pairs has been more noticeable.

If we are nearing rate cuts from the Fed, hedges for the carry trade may soon have reason to unwind those positions, similar to what showed up in July of last year. It didn’t take long after the CPI print on July 11^th but as it finally seemed the Fed had an open door to loosen rates, USD/JPY started to tank in a historic fashion. The Nasdaq near-immediately went along for the ride, and a week later, the S&P 500 joined along. It was a brutal next couple of weeks that eventually led to the VIX index spiking up to its third highest level ever on the morning of August 5^th. While cooler heads ended up prevailing then, what happened in that violent sell-off is worth investigation as a similar scenario could re-appear.

The carry trade is essentially a form of global leverage. When rates are low in Japan and high and going higher elsewhere, there’s built-in incentive for banks or pension funds or hedge funds to borrow funds from Japan at those low rates, and then invest it elsewhere in an attempt to pocket the spread. This isn’t quite arbitrage as there’s risk involved, namely in the Yen, as a Bank of Japan not adjusting rates could expose a massive risk. If the Yen loses ten or twenty percent against an investors native currency, well, that spread trade may be rendered moot, or worse, turn into a loss. So investors implementing the carry trade can look to hedge that currency risk by selling the Yen and buying another currency, such as the US Dollar or the Euro or the British Pound.

And given the rate divergence between the underlying economies, those markets can appreciate handsomely, much like we saw with the more than 50% rally in USD/JPY from the 2021 lows to the 2022 highs – and this is for an un-levered currency pair.

All is good and fine until there’s evidence of change, namely in the rate disparity between the underlying economies, such as we saw last year. And suddenly a crowded trade can go the other way very quickly, and the leverage that was pushed by the cheap rates in the first place can quickly come off. That’s what was at least part of the reason for the -15.73% sell-off in NDX from the July 10^th high to the August 5^th low.

Interestingly, it was when the Fed cut rates in September that long-term US rates started to jump, fed by inflation expectations in the U.S.; and while this was probably the opposite of what the Fed wanted or expected, it’s also something that helped equity markets to stave off disaster as that motive for carry unwind took a step back. USD/JPY hit the 140.00 handle just two days before the Fed cut rates, right as 10-year and 30-year yields were setting lows at 3.6 and 3.9%, respectively.

And as USD strength came roaring back in Q4, along with USD/JPY, so did stocks.

USD/JPY Weekly Chart

Chart prepared by James Stanley; data derived from Tradingview

USD/JPY The 140 Level

It was brief but just a couple days ahead of that rate cut the USD/JPY pair tested the 140.00 level before bouncing. On the day of the actual rate cut, buyers came in to hold a higher-low, and that led into the Q4 reversal in both USD and USD/JPY.

Dollar-bears were back at it in 2025, after the inauguration and as recession fears built around the US economy, USD/JPY again put in another test of the 140.00 handle. Again, that price held the low and going back to the high after the July FOMC rate decision, led to a 1,000+ pip move in just a few months.

Since that low there’s been an interesting divergence in price action between the USD and USD/JPY, as the Dollar pushed down to a fresh three-year low on the first day of Q3 and USD/JPY instead held a higher-low. That’s what helped to lead-in to that post-FOMC breakout a couple weeks ago, but as rate cut hopes came rushing back on the NFP report on August 1^st, so did USD/JPY sellers to drive the pair back below the 150.00 big figure.

But after that reaction, sellers haven’t been able to make much ground, until last night, that is.

Yesterday saw Treasury Secretary Scott Bessent take a hard tone towards rate policy, saying that he thought a 50 bp rate cut in September would be warranted, along with a total of 150-175 bps of cuts in total. When the Tokyo session began trading last night, the pair was slammed lower, down to a fresh August low. This highlights that the carry unwind theme still lurks in the background, and the reaction that we’ve seen so far this morning is telling.

The PPI report issued earlier today highlights that inflation isn’t soft despite the numerous claims suggesting otherwise. Producer prices are often though as a lead-in to consumer prices, but more than anything it helps to illustrate that the CPI report hasn’t been all that weak, either, as both headline and Core CPI are well-above the Fed’s 2% target.

But perhaps tracking USD/JPY as a direction manifestation of odds around FOMC is improper, and, instead, maybe this is showing us how inflation reactions and in-turn Treasury yields might react to a move of softening from the Fed, similar to what showed up last year. Given that inflation remains high and has still been moving higher, the Fed cutting rates might serve to stoke that inflation even more. And like we saw with Treasury rates last year, that expectation for greater inflation down the road, even with lower overnight rates, could feed into higher Treasury yields.

For now, the technical backdrop in USD/JPY retains a bullish touch, given the continued hold of higher-lows even as the USD has stumbled so far in 2025. The 148.13 Fibonacci level is of note and if bulls can break above that, then the 150.00 handle is back in the equation.

USD/JPY Daily Price Chart

Chart prepared by James Stanley; data derived from Tradingview

--- written by James Stanley, Senior Strategist