Yen furthers gains as bets firm on an aggressive Fed rate cut

By Vidya Ranganathan

SINGAPORE (Reuters) -The yen hit its highest levels in more than a year on Monday in trading thinned by a holiday in Japan, as market participants increasingly expected an oversized rate cut by the Federal Reserve later this week.

Trading in Asia was slow, with markets in Japan, China and South Korea closed for holidays.

The dollar was down 0.47% at 140.15 yen, falling further from the 140.285 end-December low it struck on Friday to levels last seen in July 2023. It fell 1.3% on the yen last week.

The Fed’s Sept. 17-18 meeting is the highlight of a busy week that also has the Bank of England and Bank of Japan announcing policy decisions on Thursday and Friday.

Treasury yields have been falling in the run-up to the highly anticipated meeting, particularly as odds stack up for the Fed to get aggressive with a half-point rate cut.

Benchmark 10-year yields are down 30 basis points in about two weeks. Cash Treasuries were not traded in Asia due to the Japan holiday. Two-year yields, more closely linked to monetary policy expectations were around 3.57% and down from roughly 3.94% two weeks ago.

Selling the dollar for yen has been the cleanest trade for investors looking to play the drop in Treasury yields, said Chris Weston, head of research at Australian online broker Pepperstone.

“While speculators are short and riding this lower, this trend is clearly one to align with,” and the December lows for the dollar-yen pair is one to watch, he said.

Fed speakers and data releases over the past month have had markets shifting the odds around the size of this week’s rate cut, debating whether the Fed will head off weakness in the labor market with aggressive cuts or take a slower wait-and-see approach.

On Monday, the odds were changing such that a quarter-point reduction by the Fed as it kicks off its rate cuts was no longer being priced as the most likely outcome.

Fed fund futures showed traders are pricing in a 59% chance of a 50-basis point cut at the September meeting, according to CME FedWatch. Futures priced a total of 125 basis points in rate cuts in 2024.

Investors are also looking to the Bank of Japan’s interest rate decision on Friday, when it is expected to keep its short-term policy rate target steady at 0.25%.

BOJ board members have indicated they are keen to see rates higher, and the narrowing gap between rates in Japan and other major currencies has spurred the yen higher and caused billions of dollars worth yen-funded carry trades to be unwound.

Japan is also due to see a change in political leadership, as the ruling Liberal Democratic Party is set to hold an election on Sept. 27 to pick a leader to replace Prime Minister Fumio Kishida.

Sanae Takaichi, one of the leading contenders to replace Kishida, said on Friday the Bank of Japan should hold off on further interest rate hikes, to keep the country’s economic recovery intact.

Sterling edged higher by 0.23% to $1.3155, and briefly scaled $1.31625, a 10-day high. The euro was up 0.2% at $1.1096. The dollar index was 0.15% lower at 100.87.

The European Central Bank cut interest rates by 25 bps last week, but ECB President Christine Lagarde dampened expectations for another reduction in borrowing costs next month.

ECB chief economist Philip R. Lane and Vice President Luis de Guindos speak at events on Monday.

The Bank of England is expected to hold its key interest rate at 5% next week, after kicking off its easing with a 25-bp reduction in August.

Bank of Canada Governor Tiff Macklem meanwhile opened the door to stepping up the pace of interest rate cuts, the Financial Times reported on Sunday. The BoC, after keeping its key policy rate at 5%, a more than two-decade high, for a year, has trimmed it by a quarter point three times in a row since June.