US Dollar Forecast: USD/JPY Falls as Fed Rate Cut Bets Weaken Greenback

Dollar Softens as Market Bets on Aggressive Fed Rate Cut

The U.S. dollar declined on Monday as traders positioned for a potentially aggressive interest rate cut from the Federal Reserve. The yen strengthened, hitting a 14-month high, with investors increasingly favoring the Japanese currency amid shifting U.S. monetary policy expectations.

The dollar fell to 140.01 yen after reaching a session low of 139.58, continuing its decline from Friday’s close of 140.28. This marks the lowest level for USD/JPY since July 2023, as markets focus on the Fed’s two-day policy meeting scheduled for September 17-18.

Rate Cut Speculation Intensifies

Market speculation surrounding the size of the Fed’s rate cut has intensified, with futures markets showing a 60% chance of a 50 basis point reduction. This is a sharp increase from just 15% last week, reflecting recent data and Fed commentary that suggest the central bank may act more aggressively to support a slowing labor market. A smaller 25 basis point cut is still priced in by a minority of traders.

“The dollar is softer across the board as traders focus on whether the Fed will opt for a 50-basis-point cut or a smaller 25-basis-point move,” said Niels Christensen, chief analyst at Nordea. The dollar index (DXY), which measures the greenback against a basket of six major currencies, slipped 0.3% to 100.69.

Yen Strengthens Amid Narrowing Interest Rate Differentials

The yen’s strength has been bolstered by narrowing interest rate differentials between Japan and other major economies. With the Bank of Japan (BOJ) expected to maintain its short-term interest rate at 0.25% on Friday, analysts foresee further yen gains. Investors have unwound substantial yen-funded carry trades as Japan’s rates climb and U.S. yields fall.

The benchmark U.S. 10-year Treasury yield has dropped 30 basis points over the last two weeks, currently sitting at 3.63%. Meanwhile, the two-year Treasury yield, more sensitive to Fed rate expectations, fell to 3.55%, down from 3.94% earlier this month.

Gold Jumps to Record High on Fed Rate Cut Outlook

Gold prices surged to a record high on Monday, driven by the weaker dollar and expectations of aggressive U.S. monetary easing. The precious metal, which benefits from a lower interest rate environment, gained further appeal as non-yielding assets like bullion become more attractive in times of falling yields. The prospects of a 50-basis-point cut by the Fed further boosted gold’s rally, positioning it as a safe-haven asset amid market uncertainty.

Broader Currency Moves Reflect Dollar Weakness

Elsewhere, the British pound rose 0.6% to $1.3199 as markets prepared for the Bank of England’s (BoE) decision later this week. The BoE is expected to hold rates steady at 5% after a 25-basis-point cut in August. Futures markets now assign a 38% chance of another quarter-point reduction, up from 20% last week. The euro also climbed, gaining 0.4% to trade at $1.1120 following the European Central Bank’s recent 25-basis-point rate cut.

Market Forecast: Bearish Dollar Outlook

Looking ahead, the dollar is likely to face continued downward pressure if the Fed opts for a 50-basis-point rate cut. Coupled with a potential widening in Japan’s rate differential, the yen could extend its gains further. Investors should prepare for heightened volatility in USD/JPY, particularly as the BOJ policy decision nears. Expect near-term dollar softness, especially if the Fed signals a prolonged easing cycle. Gold may continue its upward momentum as lower rates enhance its allure.