The U.S. dollar is poised to end an eight-week winning streak with its worst weekly drop since mid-August, as resilient European currencies and a surging Japanese yen pull the greenback lower.
A currency-weighted gauge of the dollar, tracked by the Invesco DB USD Index Bullish Fund ETF (NYSE:UUP), has declined more than 1.4% this week, signaling a shift in market sentiment against the greenback.
A Softening Dollar Amid Tariff Threats
Despite looming trade tariff threats from President-elect Donald Trump, the dollar has struggled to maintain its upward momentum. Trump recently reiterated his commitment to imposing a 25% tariff on goods from Mexico and Canada and an additional 10% on imports from China. Yet these aggressive trade policies failed to buoy the U.S. currency.
This week, the dollar fell 1.3% against both the euro and the British pound, but its steepest declines were against the Japanese yen.
The yen, tracked by the Invesco CurrencyShares Japanese Yen Trust (NYSE:FXY), gained significant ground amid speculation that the Bank of Japan (BoJ) could announce an interest rate hike in December.
Dollar-Yen Pair Slumps As BoJ Rate Hike Looms
The dollar-yen pair dropped to the 150 level on Friday morning, marking a 1% decline during the session and extending its weekly loss to 3%. This marks the pair's lowest levels since October 21.
The catalyst for the yen’s rally came from Thursday’s release of Tokyo's November Consumer Price Index (CPI), which surpassed expectations.
The headline inflation rate rose 2.6% year-over-year (YoY), beating forecasts of 2.2% and up sharply from October's 1.8%. Core inflation also climbed to 1.9% YoY, in line with projections but higher than the prior month's 1.8%.
Japan's October retail sales and industrial production data also indicated steady economic growth, reinforcing the narrative of an improving economy.
Masato Koike, senior economist at Sompo Institute Plus, told Reuters that increases in consumer prices have also spilled over to services-related items, which is “positive news for the BoJ in normalizing policy."
Analysts See BoJ Tightening Path
The stronger-than-expected inflation data has fueled expectations of a December rate hike by the BoJ.
According to BBVA forex analyst Alejandro Cuadrado, the Tokyo inflation numbers have significantly increased the likelihood of policy action by the BoJ on Dec. 19.
"The market is currently pricing in a 60% probability of a 15-basis-point hike to bring the reference policy rate to 0.4%," Cuadrado said.
Cuadrado also emphasized the importance of the U.S.-Japan yield differential, which could drive further yen gains in the medium term.
He added, "The BoJ will continue to raise rates, while we also think that the market could now be slightly more hawkish about what the Fed may ultimately do."
Why the Dollar-Yen Exchange Rate Matters for Stocks
The dollar-yen exchange rate has proven to be a critical barometer of global risk sentiment, particularly during periods of heightened market volatility. This dynamic was on full display over the summer, when abrupt yen appreciations in early August triggered sharp sell-offs across global equity markets.
Traders were unnerved by the prospect of an unexpected monetary tightening by the BoJ, fearing it could unravel large speculative positions — the so-called ‘carry trade’ — that had bet on a widening interest rate differential between the Fed and the BoJ.
Such a scenario would have seen significant liquidity flow back into the yen, reducing capital availability for riskier assets like stocks.
Between Aug. 2 and Aug. 5, the Nasdaq 100 — tracked by the Invesco QQQ Trust, Series 1 (NASDAQ:QQQ) — had tumbled by a cumulative 8% in three sessions, registering its worst 3-day performance in over two years.
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