Divergence in central bank policies triggers a currency war! The foreign exchange market will experience intense volatility next week

Last Week’s Currency Market Overview

In the previous trading week (12/1-12/5), the US dollar index declined by 0.50%, while non-US currencies generally strengthened. The standout performer was the Australian dollar, which rose by 1.36%; the British pound appreciated by 0.74%; the Japanese yen increased by 0.53%; and the euro gained 0.36%. This collective rally in non-US currencies reflects the market’s new expectations for multiple central banks’ policy adjustments.

Japan’s Rate Hike Probability Surges, Can Yen Appreciation Continue?

An unexpected turn has occurred in the market. According to the latest reports, Japan’s government policy stance has clearly shifted, signaling tolerance for the Bank of Japan’s rate hikes. Bank of Japan Governor Kazuo Ueda’s recent remarks have further reinforced this expectation, raising the market’s probability of a rate hike in December from previously conservative levels to about 90%.

Last week, USD/JPY fell by 0.53%, mainly reflecting the rising expectations of rate hikes. Interestingly, despite such strong expectations, the yen’s appreciation has been relatively moderate, with USD/JPY still hovering around 155.

The deeper reason lies in the market’s assessment that the real long-term interest rate differential between Japan and the US (measured by long-term interest rates minus inflation) is unlikely to narrow significantly. On one hand, under Japan’s current expansionary fiscal policy environment, inflationary pressures are expected to persist; on the other hand, market consensus believes that Japan’s rate hike plans in 2026 are relatively limited, with only one expected adjustment.

Regarding the future trend of the yen, industry opinions vary significantly. Mizuho Securities predicts USD/JPY will reach 158 by the end of 2026, while Nomura Securities is much more optimistic, estimating only 140.

Technical Outlook for This Week: USD/JPY has broken below the 21-day moving average. If the downward pressure persists below this moving average, the downside space will gradually open, with support set at 153. Conversely, if it can regain above the 21-day moving average, an oscillating upward trend will be triggered, with resistance at 157.

FOMC Rate Cut Path Becomes Focus, Euro’s Appreciation Depends on Powell’s Tone

The Federal Reserve’s policy stance remains the anchor of the global currency markets. EUR/USD rose by 0.36% last week, driven by market expectations of a rate cut by the Fed.

From a fundamental perspective, US economic data showed positive signals. The November ADP employment data unexpectedly declined, with new jobs decreasing by 32,000, marking the largest drop since March 2023. Meanwhile, the September PCE Price Index indicated signs of easing inflationary pressures, laying the groundwork for a policy shift.

According to the latest readings from the CME FedWatch Tool, the market has priced in an 87.2% chance of a 25 basis point rate cut at the December 10 meeting. Looking further ahead, the market expects two more rate cuts by 2026.

However, rate hikes or cuts are not simple binary choices; the key issue is the guidance on the magnitude of rate cuts. The Fed’s dot plot projections, the scale of bond purchases announced, and Chairman Powell’s remarks at the press conference will directly influence how the market interprets this meeting.

If the dot plot hints at more than two rate cuts in 2026 or announces bond purchase scales beyond expectations, the market will interpret this as dovish, pressuring the dollar and further boosting the euro. Conversely, if it suggests only one rate cut in 2026 and Powell’s tone is hawkish, the market will see this as a hawkish signal, supporting the dollar, with EUR/USD facing downside risks.

Technical Outlook for This Week: EUR/USD has successfully broken above the 100-day moving average, with RSI continuing upward, maintaining a robust bullish pattern. If the trend continues, the upside target is set at 1.18, with a potential challenge to the previous high of 1.1918. If it pulls back from the highs, support levels are at the 21-day moving average of 1.1593 and the previous low of 1.1491.

Key Market Focus This Week

Next week’s focus will be on the Fed’s interest rate decision and the policy responses of other central banks. Since the European Central Bank has completed its rate-cut cycle, the future rate path of the Fed will be the dominant factor influencing EUR/USD exchange rates. Additionally, any updates on the Russia-Ukraine peace talks and geopolitical developments could lead to re-pricing of risk assets and safe-haven currencies.