The yen's sharp depreciation after the Federal Reserve's hawkish rate hike has significantly raised the stakes for the Bank of Japan's policy meeting on Friday.
Strategists caution that the currency could face further weakness unless policymakers can convince the market of their commitment to additional monetary tightening.
The Fed raised borrowing costs on Wednesday for the first time since 2023, signaling further increases ahead. This move has prompted traders to price in up to three rate hikes by mid-next year, potentially widening the US-Japan yield differential despite expectations that the BOJ will also raise its policy rate this week.
The yen fell nearly 1% overnight to 156.42 per dollar following the Fed's decision. This comes after a significant rebound earlier this month, driven by expectations of faster BOJ tightening, the unwinding of yen carry trades, and speculation that Japanese pension funds might shift more assets domestically.
"Japan is under immense pressure to both hike rates and signal a hawkish stance to minimize damage," said Glenn Yin, head of research at ACCM in Melbourne. He noted that the risk of reaching 160 in the short term cannot be dismissed if the BOJ underwhelms.
The bar is set high. Overnight index swaps have almost fully priced in a 25-basis-point hike, with traders now looking to Governor Kazuo Ueda's post-meeting press conference for clues on the pace and scale of future tightening.
Hawkish board member Hajime Takata has even left the door open for a larger or back-to-back rate hike. According to Rinto Maruyama, senior rates and FX strategist at SMBC Nikko Securities, the yen's renewed weakness gives the BOJ additional reason to emphasize upside risks to inflation. He added that rising oil prices could provide further justification for tighter policy.
Maruyama suggests that Friday's expected hike would bring Japan's policy rate within the estimated neutral range, making it unlikely that officials will signal a 50-basis-point move or consecutive increases. If the meeting is perceived as dovish, he sees 158 as the next upside target for USD/JPY.
The yen remains vulnerable if investors conclude that the BOJ's tightening cycle cannot keep pace with the Fed. Maruyama believes USD/JPY could eventually approach 160 if US rates rise faster than Japan's over time.
However, there are reasons to expect that another yen selloff might be less severe than previous ones. Carry traders have suffered losses from the yen's recent strength, and hedge funds have reduced their short positions. CFTC data shows leveraged traders halved their bearish yen bets in the week through September 8.
The threat of fresh intervention could also curb depreciation. Japan and the US have demonstrated a willingness to act jointly, with Treasury Secretary Scott Bessent continuing to signal support for a stronger yen.
Friday's rate hike alone may not be enough to shore up the currency. Akira Moroga, chief market strategist at Aozora Bank Ltd, suggests the BOJ "may not adopt the same hawkish stance as the Fed, which could be a direct catalyst for yen weakness." He identifies 158.50 per dollar—near the 200-day moving average—as the next key level.