On Wednesday, the US dollar index experienced its largest daily drop in five sessions, primarily due to the ongoing strength of the Japanese yen. This surge in the yen is attributed to unwinding carry trades, safe haven flows, and increasing expectations of a rate hike in Japan following a significant rebound in Japanese private sector activity.
The yen appreciated to over 153 per dollar, its highest level in more than two months, compelling short-sellers to exit their positions. Since mid-July, the yen has strengthened by over 5% against the dollar, a movement initially sparked by suspected government intervention. Meanwhile, market risk sentiment deteriorated further as the tech-heavy Nasdaq 100 fell, prompted by a series of disappointing earnings from major European companies, which increased demand for safe havens like the yen, Swiss franc, and gold. In the US, the composite PMI rose to 55.0 in July from 54.8 in June, the highest since April 2022, indicating continuous growth over the past 18 months, with the service sector outperforming manufacturing for the fourth consecutive month. Despite this growth, employment slowed and business confidence declined due to rising political uncertainty.
The yen's rally and its potential for a significant reversal hinge on upcoming monetary policy decisions by the Bank of Japan and the Federal Reserve on July 31. While no changes to US interest rates are expected, the 2-year Treasury yield fell below 4.40% for the first time since February after New York Fed President Bill Dudley indicated that economic conditions might justify a rate cut. The first rate cut is still anticipated in September, in line with market expectations. In contrast, the likelihood of a rate hike in Japan has surged from 45% to over 80% this week, maintaining strong demand for the yen.
