Japanese Yen pares recent gains due to wide US-Japan interest rate differential

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USD/JPY peels off its daily gains due to the wide interest rate gap between Japan and the US.
US Dollar weakens as a US-Iran peace deal eases fears of inflation and higher interest rates.
The CME FedWatch tool shows the probability of a December Fed rate hold surged to 47%, up from 28% last week.

USD/JPY pares its daily gains, still remaining in the positive territory and trading around 160.10 during the Asian hours on Monday. The Japanese Yen (JPY) has found a solid foothold in the wake of the geopolitical breakthrough. The reopening of the Strait of Hormuz caused oil prices to plunge to a two-month low, significantly easing inflationary pressures and reducing crippling import costs for energy-dependent economies like Japan.

However, the JPY's upside remains capped, as the substantial interest rate gap between Japan and the United States (US) continues to provide structural support to the USD/JPY pair. The JPY may receive further domestic support as traders price in a potential Bank of Japan (BoJ) interest rate hike on Tuesday to contain local inflation.

The USD/JPY pair depreciated as the US Dollar (USD) declined following reports that the United States (US) and Iran reached a deal to end their conflict, easing concerns about inflation and higher interest rates.

Following a landmark peace agreement between the United States (US) and Iran, market expectations for monetary policy have shifted dramatically. The CME FedWatch tool now indicates a nearly 47% probability that the Federal Reserve (Fed) will hold interest rates unchanged in December, a sharp increase from the 28% priced in just last week.

The deal, announced on Sunday by Washington and Tehran, is set to take effect this Friday. As part of the agreement, US President Donald Trump stated that the United States will lift its naval blockade on Iranian ports, allowing the critical Strait of Hormuz to reopen. In a coordinated response, the United Kingdom, France, Germany, and Italy announced they are prepared to lift sanctions on Iran following steps taken regarding its nuclear program.

Japanese Yen FAQs

What key factors drive the Japanese Yen?

The Japanese Yen (JPY) is one of the world’s most traded currencies. Its value is broadly determined by the performance of the Japanese economy, but more specifically by the Bank of Japan’s policy, the differential between Japanese and US bond yields, or risk sentiment among traders, among other factors.

How do the decisions of the Bank of Japan impact the Japanese Yen?

One of the Bank of Japan’s mandates is currency control, so its moves are key for the Yen. The BoJ has directly intervened in currency markets sometimes, generally to lower the value of the Yen, although it refrains from doing it often due to political concerns of its main trading partners. The BoJ ultra-loose monetary policy between 2013 and 2024 caused the Yen to depreciate against its main currency peers due to an increasing policy divergence between the Bank of Japan and other main central banks. More recently, the gradually unwinding of this ultra-loose policy has given some support to the Yen.

How does the differential between Japanese and US bond yields impact the Japanese Yen?

Over the last decade, the BoJ’s stance of sticking to ultra-loose monetary policy has led to a widening policy divergence with other central banks, particularly with the US Federal Reserve. This supported a widening of the differential between the 10-year US and Japanese bonds, which favored the US Dollar against the Japanese Yen. The BoJ decision in 2024 to gradually abandon the ultra-loose policy, coupled with interest-rate cuts in other major central banks, is narrowing this differential.

How does broader risk sentiment impact the Japanese Yen?

The Japanese Yen is often seen as a safe-haven investment. This means that in times of market stress, investors are more likely to put their money in the Japanese currency due to its supposed reliability and stability. Turbulent times are likely to strengthen the Yen’s value against other currencies seen as more risky to invest in.