Why is the Japanese Yen weakening as upbeat US NFP bolsters a hawkish Fed outlook?

USD/JPY ends two days of losses as robust US Nonfarm Payrolls bolster the Greenback.
Expectations of another Fed rate hike in December strengthen following resilient US labour market figures.
The Yen faces pressure from lower JGB yields, countering the benefit of safe-haven buying.

USD/JPY returns to gains on Friday after two consecutive days of declines, with the US Dollar’s (USD) yield advantage over the Japanese Yen (JPY) drawing renewed attention. The recovery follows US employment figures that exceeded expectations and strengthened the Dollar. Having touched an intraday low of 157.26, USD/JPY is trading near 158.30 at the time of writing.

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Employers added 165K jobs in October, according to the US Nonfarm Payrolls report, far exceeding the forecast of 65K. Further evidence of labour market resilience comes from upward revisions to September’s job gains, unemployment declining to 4.1% and wage growth beating expectations.

With the employment report giving the Federal Reserve (Fed) little reason to ease its focus on inflation, a December rate increase remains firmly on the table. Speaking on Friday, St. Louis Fed President Alberto Musalem said inflation must return to 2% “on a timely basis,” and added that “excess inflation today is coming from energy shocks and the AI buildout.”

Trading near 102.15, the US Dollar Index (DXY) has recovered from the five-week low of around 101.20 recorded earlier this week. The index measures the Greenback against a basket of six major currencies. US Treasury yields have also turned higher, with the benchmark 10-year yield gaining 4 basis points (bps) to reach 4.88%.

Further Dollar gains are being restrained, however, by easing US consumer inflation expectations. The University of Michigan’s preliminary figures put one-year expectations at 4.3% in November, down from 4.7%. Expectations over five years slipped to 3.4% from 3.5%.

An AI-led sell-off in equities initially drew safe-haven flows into the Japanese Yen. Yet buying also extended to Japanese Government Bonds (JGBs), lowering domestic yields and partly cancelling out the currency’s support from risk aversion.

At around 2.63%, Japan’s benchmark 10-year yield is close to a four-month low, having fallen more than 4% on the day. The yield differential with the corresponding US bond consequently stands near 225 bps. In these conditions, the Yen receives only modest support from the Bank of Japan’s (BoJ) hawkish outlook.

The possibility of Japanese intervention nevertheless discourages traders from building aggressive bullish positions in USD/JPY. Since late September, the pair has traded within a range, having recovered from an earlier intervention-led decline that briefly took it below 154.00.

Questions about the Fed

How does the Federal Reserve’s role influence the US Dollar?

The Federal Reserve (Fed) sets US monetary policy with a dual mandate: maintaining price stability and promoting full employment. Adjustments to interest rates are its main means of pursuing these objectives. If prices climb too rapidly and inflation exceeds the Fed’s 2% target, the central bank increases interest rates. Borrowing then becomes more expensive across the economy. By making the US a more attractive destination for international investors’ funds, higher rates strengthen the US Dollar (USD). Conversely, inflation below 2% or an excessively high unemployment rate may prompt the Fed to cut interest rates. Such cuts encourage borrowing but put pressure on the Greenback.

How frequently does the Fed meet to decide monetary policy?

At eight policy meetings each year, the Federal Open Market Committee (FOMC) of the Federal Reserve (Fed) reviews economic conditions and decides monetary policy. Twelve Fed officials take part: all seven members of the Board of Governors, the president of the Federal Reserve Bank of New York and four presidents from the other eleven regional Reserve Banks. These four serve rotating one-year terms.

How does Quantitative Easing (QE) work, and what does it mean for USD?

Quantitative Easing (QE) is a policy the Federal Reserve may turn to in extreme circumstances to sharply expand the flow of credit through a stalled financial system. This unconventional measure is used in crises or periods of exceptionally low inflation. The Fed favoured it during the Great Financial Crisis in 2008. Under QE, the central bank prints additional Dollars to purchase high-grade bonds from financial institutions, a process that generally weakens the US Dollar.

How does Quantitative Tightening (QT) work, and what does it mean for the US Dollar?

By reversing QE, Quantitative tightening (QT) sees the Federal Reserve halt bond purchases from financial institutions. It also stops reinvesting principal repaid on its maturing bond holdings in new bonds. This process generally supports the US Dollar’s value.