Two weeks ago, the Bank of Japan and the US Treasury intervened in the USD/JPY exchange rate, briefly reversing the yen's depreciation. However, after the intervention, bullish funds returned, and the currency market returned to a state of flux. Historical data shows that, compared to temporary market interventions, US CPI inflation data often dominates major USD/JPY price movements . The market is currently pricing in a near 80% probability of at least one 25 basis point rate hike by the US this year. The upcoming inflation data will directly reshape interest rate expectations, carry trades, and the future direction of the USD/JPY exchange rate.

Interest rate expectations dictate the direction of the foreign exchange market.

The underlying driver of the USD/JPY exchange rate is the divergence in interest rate expectations between the US and Japan, with inflation data being the most important indicator of these expectations. Disruptions in the Middle East have led to rising oil prices and increased US inflation, prompting a growing number of Federal Reserve officials to signal a tightening stance. They hope to learn from the lessons of 2021 and avoid simply characterizing inflation as temporary, thus preventing a forced aggressive rate hike later. Currently, the probability of a September rate hike is 50/50, and the strength of inflation data will be crucial in determining the outcome. Federal Reserve Chairman Kevin Warsh's overall stance leans towards hawkishness, a position with practical considerations. President Trump wants to select a Fed chairman who favors rate cuts, and Warsh's deliberate hawkish signals aim to prevent the market from forming a fixed expectation of unconditional rate cuts. If the market interprets him as hawkish, US Treasury yields will rise rapidly. With a large amount of US Treasury debt maturing in the coming months, high yields will significantly increase debt repayment pressure. Warsh has repeatedly emphasized that the market should price interest rates based on comprehensive data; however, the market is still heavily betting on a rate hike this year, supporting a stronger dollar and pushing up the USD/JPY exchange rate. Once expectations of interest rate hikes subside, the upward trend of the US dollar and the USD/JPY exchange rate will also adjust accordingly.

Historical Review: US CPI Has Repeatedly Triggered Major Fluctuations in the USD/JPY Exchange Rate

Looking back over the past four years, the triggers for multiple rounds of sharp fluctuations in the USD/JPY exchange rate have all stemmed from US CPI data. Intervention actions have often only created short-term disturbances and failed to alter the overall trend. During the aggressive interest rate hikes by the Federal Reserve in 2022, the USD/JPY exchange rate surged rapidly. Japanese authorities intervened multiple times at levels such as 145 and 151.95, only resulting in brief pullbacks, with bulls quickly re-entering the market. It wasn't until the lower-than-expected CPI data in November 2022 that the market began trading on policy shifts, leading to a 2,000-point drop in the exchange rate. Subsequent market movements similarly confirmed the decisive role of inflation data. In April 2024, the higher-than-expected CPI data directly broke through key resistance, pushing the USD/JPY exchange rate towards the 160 level. In July of the same year, the Bank of Japan intervened during the CPI release period. Coupled with lower-than-expected inflation, the market confirmed that the Federal Reserve had room to cut interest rates, resulting in a significant pullback in the USD/JPY exchange rate and even a correction in the booming AI sector. Carry trades are the core driver of USD/JPY price movements; changes in inflation directly alter the USD/JPY interest rate differential, driving large-scale position openings and closings. Since the beginning of 2021, the USD/JPY exchange rate has risen by more than 50%, accumulating a large number of long positions in the market. Once these long positions are liquidated, it will also cause the USD to weaken in other currency pairs.

Conclusion

In summary, foreign exchange intervention, being an external force, can only disrupt prices in the short term. Inflation data, by changing interest rate expectations, is the core variable determining the medium- to long-term direction of the USD/JPY exchange rate. The upcoming US CPI data will reassess the probability of a Fed rate hike, affecting both the US Treasury market and the large carry trade positions, thus dominating the next phase of the USD/JPY exchange rate movement. USD/JPY Daily Chart Source: FX678 At 10:44 AM Beijing Time on August 12, USD/JPY was trading at 159.39/40.