Will the Federal Reserve's decision control the Bank of Japan's interest rate hike fate? December exchange rate reversal risk emerges

Recently, the Japanese yen has been stuck in a stalemate, with USD/JPY oscillating repeatedly at high levels, and market sensitivity to policy changes has clearly increased. The Japanese government has sent a strong signal, with Prime Minister Fumio Kishida announcing strict monitoring of abnormal exchange rate fluctuations and readiness to implement “necessary” intervention measures in the foreign exchange market at any time.

This reflects an increasing expectation of rate hikes by the Bank of Japan. Market news indicates that the BOJ may initiate a rate hike in December, which would directly impact the current depreciation trend of the yen. Since this news was released, USD/JPY has retreated from its high point, once falling below the 156 level, with hawkish voices continuously rising.

The Federal Reserve is the Decider

The true power controlling the situation lies across the Atlantic. The BOJ is scheduled to announce its interest rate decision on December 19, while the Fed’s decision will be announced a week earlier, creating a substantial time gap that constrains Tokyo’s decision-making.

Analysis suggests that if the Fed maintains current interest rates, the BOJ will face greater pressure to hike. Conversely, if the Fed chooses to cut rates, the BOJ has more reason to hold steady. Currently, market expectations for rate hikes are highly dispersed—about a 50% chance of a December hike and a 50% chance of a January hike, indicating market indecision amid the ongoing debate.

ANZ Bank analyst Carol Kong pointed out that the cautious BOJ tends to wait until the parliament passes the budget bill before acting, which can delay the pace of rate hikes and buy time to study the next wage negotiation trends.

Narrowing Interest Rate Differentials Hide Risks

The rising expectation of BOJ rate hikes combined with increasing expectations of Fed rate cuts has led to a continued narrowing of the US-Japan interest rate differential. Theoretically, this trend would increase the likelihood of USD/JPY falling back from high levels. But reality is more complex.

The interest rate differential between Japan and the US remains substantial, and arbitrage trading remains vigorous, so the pressure for yen depreciation has never truly dissipated. UBS FX strategist Vassili Serebriakov warned that a single rate hike alone is unlikely to reverse the yen’s overall trend unless the BOJ adopts a hawkish stance and commits to further hikes into 2026 to control inflation. He emphasized, “The US-Japan interest rate differential remains large, and volatility is still low,” implying limited room for reversal.

Policy Intervention: A Double-Edged Sword

Jane Foley, Head of FX Strategy at Rabobank, offered an intriguing perspective: market concerns about BOJ intervention might itself act as a restraining force on the dollar’s rise, thereby reducing the actual need for intervention. While intervention during Thanksgiving is possible, expectations often surpass reality.

This is precisely the dilemma facing the market now. Although frequent policy signals from Japan resemble a “relay” approach, their concrete effects remain hard to gauge. Investors are seeking a balance amid policy uncertainty and exchange rate volatility.

Overall, December will be a critical turning point. The Fed’s decision will directly influence the BOJ’s options, and whether the yen can truly appreciate depends on the outcome of this policy contest. With interest rate differentials still present and arbitrage activity active, even if hikes are implemented, the upside for the yen will be limited. Market participants should prepare for risks associated with potential exchange rate reversals.