Washington D.C: The US Dollar (USD) experienced a broad rally on Monday, holding near a two-year high. In contrast, the Japanese yen edged up slightly from five-month lows against the greenback as traders continued to assess the Federal Reserve’s interest rate policy for the coming year.
Dollar Rally Driven by Fed Outlook
The US dollar has gained momentum in recent weeks, fueled by expectations of a less dovish stance from the Federal Reserve. With inflation consistently above the Fed’s target of 2% per year, analysts anticipate that the central bank will implement fewer rate cuts in 2025 than previously expected. In its latest meeting, the Fed reduced its interest-rate forecast for 2025 to a potential 50 basis points cut, down from an earlier estimate of 100 basis points. Fed Chair Jerome Powell emphasized that any further reductions in borrowing costs will depend on substantial progress in curbing inflation.
As a result, the dollar index is projected to achieve a 6.7% gain this year, trading up 0.18% on the day at 108.17 after reaching a two-year high of 108.54 on December 20.
Yen Performance and Interest Rate Differential
The Japanese yen has been adversely affected by the widening interest rate differential between Japan and the United States. Currently, the dollar is set to return 11.4% against the yen for the year, marking its fourth consecutive yearly increase. However, the yen was last down 0.46% at 157.09 yen to the dollar.
Some analysts believe that the yen may strengthen in 2024 if the Bank of Japan (BoJ) decides to raise interest rates while the Fed eases its monetary policy. Despite this potential, rising U.S. Treasury yields have yet to be reflected in the current exchange rate. Fawad Razaqzada, a market analyst at City Index, noted that persistent above-target inflation could lead to increased price pressures if the yen continues to weaken. To support its currency, the BoJ may need to consider more significant rate hikes.
BoJ Rate Hike Expectations
Recent insights from the BoJ indicate that some policymakers believe conditions are aligning for an imminent rate hike. One member even predicted a possible move “in the near future,” suggesting that a hike could occur as early as January. Traders are closely monitoring the situation, particularly any potential intervention by Japanese officials if the yen continues its downward trajectory.
Japan’s Finance Minister, Katsunobu Kato, reiterated concerns over the declining yen on Friday, warning that the government would take action against excessive currency fluctuations.
Eurozone Outlook
The euro is also under pressure, heading for a 5.7% decline against the dollar this year. This drop follows four interest rate cuts by the European Central Bank (ECB) in 2024, with markets expecting the ECB to adopt a faster pace of rate cuts compared to the Fed in 2025. The euro was last down 0.29% at $1.0397. ECB Governing Council member Robert Holzmann remarked that the next interest rate cut by the ECB might take longer to materialize due to a recent uptick in inflation.
Conclusion
As traders navigate the shifting landscape of global interest rates, the US dollar maintains its strength while the Japanese yen faces challenges amid potential policy changes. With the Federal Reserve’s cautious approach and the Bank of Japan’s hints at rate hikes, the currency markets will be closely monitored in the coming months for further developments and implications for global economic stability.
