Japan's interest rate hike is coming, which is favorable for the yen; the dollar is under pressure as rate-cut trades return. The next Federal Reserve chair may be dovish.---1203 Macro Desiccation

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1. Recently, the Governor of the Bank of Japan sent a clear signal of interest rate hikes, causing the USD/JPY exchange rate to briefly fall and then rebound. Currently, the market focus has shifted towards the rate hike path extending to 2026. The Finance Minister stated respect for the central bank's autonomy in monetary policy. In the future, the linkage effect between monetary policy and exchange rate policy will become the core variable affecting the yen's trend.
2. This year, the US dollar's performance diverged before and after mid-year. In the first half, impacted by employment data and “reciprocal tariffs”, the US Dollar Index dropped sharply, triggering a wave of "de-dollarization" trades. In the second half, the dollar entered a sideways consolidation phase. Looking ahead, the suppression of the labor market by artificial intelligence technology and expectations of rate cuts will cause the dollar to face renewed downward pressure.
3. The expectation of a Fed rate cut in December has become consensus, mainly based on rising unemployment and official statements. Subsequent policy paths will depend on economic fundamentals and the next Fed Chair. Although the next chair may lean more dovish, the committee’s consensus decision-making and data-dependency principle will limit the scope for aggressive rate cuts.

I. Pending BOJ Rate Hikes to Benefit Yen

Pending BOJ Rate Hikes to Benefit Yen (Nomura)

Nomura pointed out that recently the Governor of the Bank of Japan sent a clear signal of rate hikes, causing the USD/JPY exchange rate to briefly fall and rebound. Currently, market focus has extended to the rate hike path through 2026. The Finance Minister stated respect for the central bank's autonomy. The linkage of future monetary and exchange rate policies will become the core variable affecting the yen’s movement.

1. USD/JPY briefly fell below 155 and then rebounded.
   • BOJ Governor Kazuo Ueda’s remarks sent a signal of rate hikes, strengthening the yen. The USD/JPY rate once fell below 155 but then recovered.
   • For the yen to continue strengthening, it requires not only consolidation of rate hike expectations in December but also market anticipation of further hikes into 2026, reaching a higher terminal rate.
2. The government maintains a non-interference attitude towards the BOJ.
   • Finance Minister Mayumi Katayama stated there is no difference of opinion between the government and the BOJ regarding economic assessment, so there are currently no objections to a rate hike and emphasized that the central bank independently decides on monetary policy implementation.
   • She mentioned that "there is volatility in financial markets", and the government and BOJ are closely monitoring corporate trends. This suggests that facing yen weakness and rising bond yields, the government may have raised its tolerance for BOJ rate hikes.
3. The reason for a possible December BOJ rate hike could be the risk of rising inflation due to yen depreciation.
   • Without monetary policy intervention, it would be hard to gain US support; if rate hikes are used to address yen weakness, the Finance Ministry will find it easier to justify forex intervention.
   • If a rate hike is implemented, the market should be more alert to intervention risks if the yen weakens again. The risk of USD/JPY breaking above 160 and surging has been reduced.

Recent developments indicate that even under Sanae Takaichi’s administration, when the yen weakens, rate hikes may be advanced, while the risk of currency intervention remains.

II. US Dollar Faces Pressure as Rate Cut Trades Return

US Dollar Faces Pressure as Rate Cut Trades Return (CICC)

CICC pointed out that the dollar’s performance this year diverged before and after mid-year. In the first half, employment data and “reciprocal tariffs” hit the dollar index hard, triggering “de-dollarization” trades. In the second half, the dollar entered a sideways phase. Looking ahead, AI’s suppression of the labor market and rate-cut expectations will bring renewed pressure on the dollar.

1. In the first half, the dollar sharply depreciated overall.
   • In Q1, a series of post-inauguration Trump policies underperformed expectations, causing the dollar index to fall from highs.
2. In the second half, the dollar index entered a sideways consolidation phase.
   • After the US and trade partners in Europe, UK, and Japan reached tariff agreements, market concerns about US economic and financial stability eased, slowing “de-dollarization” processes.
   • However, with September’s rate cuts and rising political uncertainty in non-US countries, the market temporarily lacks new trading themes.
3. A weak job market and US government pressure may bring back rate-cut trades.
   • AI-related investment is contributing more to US economic growth, decreasing the role of labor in production, lowering employment, and affecting consumption and inflation. Markets may anticipate rate cuts to boost job creation.
   • Kevin Hassett, head of the National Economic Council, is a candidate for the next Fed Chair, supported by Trump’s advisers and allies. Hassett favors lowering rates, so if he is selected, the market may price in a more aggressive rate-cut path, leading to dollar weakness.

In Q2, the dollar index saw a significant drop: on one hand, easing US employment data raised the prospect of rate cuts; on the other, “reciprocal tariffs” exceeded market expectations. Markets began to worry about the stability of US economic returns—initiating a “de-dollarization” trade, reducing dollar holdings, and hedging against dollar-exposed assets.

III. Next Fed Chair May Be Dovish

Next Fed Chair May Be Dovish (BofA)

Merrill Lynch points out that market consensus is for a Fed rate cut in December, mainly due to rising unemployment and official comments. The future policy path will be influenced by economic fundamentals and the next chair. Although the next chair may lean dovish, the committee’s consensus and data-driven approach will limit room for aggressive cuts.

1. The Fed is expected to cut rates by 25 basis points in December, and twice more by 25 basis points next year, leaving the terminal rate at 3.0-3.25%, for four reasons:
   • September unemployment rate rose to nearly 4.5%; Fed Vice Chair Williams acknowledged the case for rate cuts; ADP data and the Beige Book show economic weakness; before the blackout period, market pricing reflected over 80% probability of a rate cut, with no official rebuttal.
2. Kevin Hassett is currently the top candidate for the next chair.
   • If confirmed, he may push for larger rate cuts, but as long as the economy remains stable, his views may not gain support.
   • Unless warranted by economic conditions, the next Fed Chair will find it hard to convince the FOMC to push rates below 3%.
3. Holiday spending and PMI data will draw market attention.
   • US economic data releases are gradually resuming. This week, markets will focus on ISM Manufacturing and Services PMI to judge if economic activity is slowing, inflation is rebounding, or employment is contracting.
   • Boosted by "Black Friday" and "Cyber Monday" promotions, holiday spending is peaking. Preliminary figures show holiday sales are up year-on-year.

If the Fed cuts more than justified by fundamentals, long-term Treasury yields may rise, potentially having a greater economic impact than the policy rate itself.

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