Japanese Yen weakens as stronger US Dollar and elevated energy prices weigh on sentiment

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USD/JPY remains on track for a second consecutive weekly gain as the Greenback stays broadly supported.
Traders increasingly price in the possibility of a Fed rate hike by year-end following stronger US inflation expectations data.
Softer Japanese inflation data does little to alter expectations for a potential Bank of Japan rate hike in June.

USD/JPY holds firm on Friday, remaining confined within this week’s trading range as traders refrain from placing aggressive bullish bets near the 160.00 handle following suspected intervention by Japanese authorities in late April. At the time of writing, the pair is trading around 159.20 and remains on track for a second consecutive weekly gain.

Meanwhile, the US Dollar (USD) remains supported as no meaningful progress has emerged despite ongoing diplomatic efforts to end the war in the Middle East, while disagreements over Iran’s nuclear programme continue to weigh on negotiations. The US Dollar Index (DXY), which tracks the Greenback's value against a basket of six major currencies, remains near six-week highs around 99.32.

In contrast, elevated Oil prices linked to ongoing supply disruption risks in the Strait of Hormuz continue to weigh on the Japanese Yen (JPY), as Japan relies heavily on imported energy from the Middle East, with a significant portion of its crude Oil imports passing through the strategic waterway.

Adding to US Dollar support, the final reading of the University of Michigan’s Consumer Sentiment Index fell to 44.8 in May from 48.2 previously, while the Consumer Expectations Index declined to 44.1 from 48.5. Meanwhile, the 1-year Consumer Inflation Expectations rose to 4.8% from 4.5%, while the 5-year inflation outlook climbed to 3.9% from 3.4%.

The sharp rise in inflation expectations signals growing consumer concerns over the impact of higher Oil prices. Against this backdrop, traders are increasingly pricing in the possibility of a Federal Reserve (Fed) rate hike by the end of the year, compared with earlier market expectations for at least two rate cuts before the war began.

White House Senior Adviser Kevin Hassett said on Friday that central banks must pay close attention to the ongoing Oil shock, while warning that higher energy prices could feed into core inflation.

Fed Governor Christopher Waller said, “If shorter-run inflation expectations go up, that’s alarming, we might have to take steps then.” Waller added that “the current position is to hold rates steady in the near term,” while stressing that inflation will remain “the driving force in policy decisions ahead.

In Japan, inflation data released earlier in the day came in softer than expected, though traders still expect the Bank of Japan (BoJ) to raise interest rates at its June meeting.

Fed FAQs

What does the Federal Reserve do, how does it impact the US Dollar?

Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability and foster full employment. Its primary tool to achieve these goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, it raises interest rates, increasing borrowing costs throughout the economy. This results in a stronger US Dollar (USD) as it makes the US a more attractive place for international investors to park their money. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates to encourage borrowing, which weighs on the Greenback.

How often does the Fed hold monetary policy meetings?

The Federal Reserve (Fed) holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions. The FOMC is attended by twelve Fed officials – the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who serve one-year terms on a rotating basis.

What is Quantitative Easing (QE) and how does it impact USD?

In extreme situations, the Federal Reserve may resort to a policy named Quantitative Easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used during crises or when inflation is extremely low. It was the Fed’s weapon of choice during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy high grade bonds from financial institutions. QE usually weakens the US Dollar.

What is Quantitative Tightening (QT) and how does it impact the US Dollar?

Quantitative tightening (QT) is the reverse process of QE, whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing, to purchase new bonds. It is usually positive for the value of the US Dollar.