USD/JPY volatility shifts focus to Japan's fiscal policy and U.S. interest

The USD/JPY exchange rate experienced significant volatility in September, fluctuating between 152 and 159 yen. A sharp drop to the 152 level was likely driven by aggressive yen-buying from hedge funds following the breach of the 120-day moving average. However, the pair rebounded toward 159 yen as interest rate differentials widened following rate hikes by both the Bank of Japan and the Federal Reserve.

Market dynamics are shifting from a simple focus on interest rate differentials to a more complex interplay between monetary policy and fiscal stability. While the Bank of Japan has moved toward normalizing policy, concerns regarding Japan's fiscal health remain a critical factor. If interest rates rise due to fiscal deterioration rather than policy normalization, it could trigger a ‘triple sell-off’ of the yen, bonds, and stocks.

U.S. involvement is also increasing. U.S. Treasury Secretary Bessent has expressed support for addressing the yen's undervaluation, noting its impact on Japanese inflation. Furthermore, the U.S. maintains a close interest in Japanese interest rates due to Japan's status as a major holder of U.S. Treasuries; significant shifts in Japanese rates could impact U.S. debt market stability and capital repatriation.