Japanese Yen struggles as wide US-Japan yield gap weighs

• The Japanese Yen weakens as domestic bond yields retreat sharply.
• A wide US-Japan yield gap and a firm US Dollar support USD/JPY.
• Intervention concerns near 160 keep bullish bets in check.

USD/JPY trades with a positive bias on Friday as the Japanese Yen (JPY) underperforms across the board following a sharp decline in Japanese government bond yields. Japan’s relatively low interest rates and concerns over the country’s fiscal outlook remain additional headwinds for the Yen, while a firmer US Dollar (USD) provides further support to the pair. At the time of writing, USD/JPY trades around 158.30, on track for a fourth consecutive weekly gain.

The global bond sell-off loses some momentum, with Japan’s 10-year government bond yield easing toward 3.00% from the 3.153% peak reached earlier this week, its highest level in 30 years. Meanwhile, the 10-year US Treasury yield holds near 5.248%, below the 5.365% peak, its highest since 2002. This leaves US yields roughly 225 basis points (bps) above their Japanese counterparts.

The Greenback remains firmly bid as Oil-driven inflation risks keep US Treasury yields elevated and reinforce expectations that the Federal Reserve (Fed) will raise interest rates again before the end of the year. The US Dollar Index (DXY), which tracks the Greenback against a basket of six major currencies, trades around 102.30 after recovering from an intraday low near 101.92.

According to the CME FedWatch Tool, markets widely expect the Fed to leave interest rates unchanged at its October 27-28 meeting but price in an 85% probability of a rate hike in December. Data released on Friday showed that the University of Michigan’s 1-year inflation expectation rose to 4.7% from 4.6%, while the 5-year measure increased to 3.5% from 3.4%. Attention now turns to next week’s US Consumer Price Index (CPI) data.

On the Japanese side, the Bank of Japan (BoJ) remains on a gradual tightening path. However, with other major central banks also maintaining a hawkish stance, higher Japanese interest rates provide only limited support to the Yen.

Japan’s large debt burden and rising borrowing costs have increased investor concerns about the government’s finances, even as Prime Minister Sanae Takaichi has pledged to keep government bond issuance under control. Takaichi said on Friday that authorities would closely monitor movements in the Yen and inflation and respond in line with economic conditions.

Elevated Oil prices pose another near-term risk for the energy-dependent economy by increasing import costs and adding to inflationary pressure. These factors keep the Yen on the back foot, although traders remain cautious about building large bullish positions in USD/JPY due to the risk of official intervention as the pair holds close to the 160 level.