Yen Holds Gains on Hawkish BOJ Bets as Dollar Stays Soft on Fed Expectations

USD/JPY extended its weakness on Friday, trading around 158.54, edging slightly lower on the day. The pair had rebounded from a one-and-a-half-week low near the 158.00 mark but failed to hold gains, encountering selling pressure once again, and is on track to post its first weekly decline in three weeks.

**Hawkish BOJ Bets Provide Short-Term Support**

Rising market expectations for further policy tightening by the Bank of Japan continue to lend some support to the yen. According to Bloomberg Terminal data, markets have priced in 45 basis points of BOJ tightening by year-end. However, this tailwind has had a relatively limited impact on the yen. Junya Tanase, head of Japan FX strategy at JPMorgan, noted that the yen's fundamentals are quite weak, and this situation is unlikely to change significantly next year.

**Dollar Weakness and Structural Factors Intertwine**

On the dollar side, cooling expectations for Fed rate hikes are weighing on the greenback overall, which also caps upside for USD/JPY. Yet, the deeper pressures on the yen remain unrelieved. Carry trades have continued to make a comeback, with investors borrowing low-yielding yen to invest in higher-yielding currencies, a strategy that suppresses yen rebounds. Parisha Saimbi, strategist at BNP Paribas, expects carry trades to continue benefiting in a global macro environment relatively favorable to risk appetite, with USD/JPY potentially reaching 160 by end-2026.

**Intervention Risk Caps Upside but Unlikely to Change Trend**

While the possibility of FX intervention by Japanese authorities, coupled with hawkish BOJ rhetoric, limits upside for USD/JPY above the 160 threshold, Bloomberg Intelligence analysis suggests that under a broadly strong dollar backdrop, as long as FX intervention remains a unilateral Japanese action, a fundamental shift in the yen's trajectory remains difficult to achieve. Market reports indicate that leveraged funds' bearish positioning on the yen has recently remained near highs not seen since July 2024, underscoring the market's pessimistic outlook on the currency.