Bets on rate hikes fade, yen set for its biggest weekly drop this year

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As bets on another rate hike by the Bank of Japan quickly fade, the yen is heading for its worst week in a year.

On October 10, the yen hovered around 153 against the U.S. dollar during the Asian morning session, staying at its lowest level since mid-February this year. So far this week, the yen has fallen by nearly 4%, set to record its largest single-week drop since early October last year.

The sharp decline in the yen's exchange rate centers on market concerns that the unexpected victory of dovish fiscal policy advocate Sanae Takaichi will reduce the likelihood of another rate hike by the Bank of Japan this year. Sanae Takaichi, who is about to become Japan’s first female prime minister, said Thursday that while the Bank of Japan sets monetary policy, any of its decisions must align with government objectives—exacerbating market doubts about the central bank’s independence.

Political Changes Lead to Major Rate Hike Expectations Downgrade

Market pessimism about Japan’s monetary policy prospects is closely tied to the upcoming appointment of Sanae Takaichi. Investors generally believe her stance on fiscal policy is dovish and may pose political obstacles to future rate hikes by the Bank of Japan.

Carol Kong, currency strategist at Commonwealth Bank of Australia, said, "The market still believes that Takaichi's leadership will make it politically difficult for the Bank of Japan to raise rates."

With the change in the political landscape, traders have drastically adjusted their expectations for Bank of Japan policy. According to market pricing, traders now expect about a 45% chance of a rate hike at the December BOJ meeting.

For the longer path, the market has now fully priced in a 25-basis-point rate hike in March next year. This shows that investors have shifted hopes of tightening policy to further in the future.

Meanwhile, expectations for Japanese authorities to intervene in the currency market are also weakening. According to Carol Kong’s analysis, recent comments by Finance Minister Shunichi Kato about the forex market indicate “the likelihood of immediate intervention is low, which may encourage further yen selling.”

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