The Federal Reserve's policy shift is imminent! Rate hikes are causing a major upheaval in the exchange rate landscape

Rate Cut Expectations Reverse, the US Dollar Faces Adjustment Pressure

The biggest concern in the forex market this week is whether the Federal Reserve will cut interest rates in December. As officials continue to signal a hawkish stance, market confidence in a rate cut has significantly declined—currently, the probability of a 25 bps rate cut is only 45.8%, while the chance of holding rates steady has risen to 54.2%. This shift in expectations directly impacts the relative strength of the US dollar against other major currencies.

After the US government ended the longest shutdown in history lasting 43 days, market focus shifts to economic data. The November 20th September non-farm payroll report, the November 26th Q3 GDP revision, and the October PCE Price Index will be key in assessing the Fed’s stance. If the labor market continues to weaken, expectations for rate hikes will be further subdued, putting pressure on the dollar; conversely, strong employment data will reinforce rate hike expectations and boost the dollar.

EUR/USD Builds Up for an Upside, Rate Hike Impact Changes the FX Landscape

Last week, EUR/USD rose by 0.46%, which directly reflects the loosening of rate hike expectations triggered by soft US employment data. On the technical side, the pair has broken above the 21-day moving average but has yet to surpass the critical resistance at the 100-day moving average of 1.166. A successful break above this level could open up further upside space; failure to do so increases downside risk, with support at the previous low of 1.146.

This week, the release of US non-farm data, Eurozone and US PMI data for November, and the publication of the October FOMC minutes will deeply influence the future trend of EUR/USD. The logic behind the Fed’s rate hikes affecting the exchange rate is: the weaker the rate cut expectations, the more pressure the dollar faces.

Yen Depreciation, the New Political Economy of Rate Hike Impact on FX

USD/JPY rose by 0.73% last week, driven by Japan’s new Prime Minister, Sanae Takaichi, hinting that the Bank of Japan will slow down its rate hike pace. This policy tilt, combined with market concerns over Japan’s expansionary fiscal policies, continues to exert downward pressure on the yen.

It is worth noting that the Takaichi government will announce an economic stimulus package of about 17 trillion yen this week. Goldman Sachs warns that the unexpectedly large stimulus could reignite market concerns over Japan’s fiscal discipline, potentially pushing long-term sovereign bond yields to historic highs and further depressing the yen. This reflects another logic of how rate hikes influence the exchange rate—currency depreciation under easing expectations.

Mitsubishi UFJ Morgan Stanley Securities expects that Japan’s authorities may tolerate the exchange rate rising to around 161 yen per US dollar to protect foreign exchange reserves.

Technical Outlook: Further Testing of Previous Highs

USD/JPY is currently above multiple moving averages, with RSI indicating strong bullish momentum. It may further test the 155 level; a successful breakthrough could open up more upside potential. The key support level is the 21-day moving average at 153.38.

This week, focus should be on US September non-farm data, FOMC minutes, Eurozone and US PMI, and Japan’s economic stimulus plan. The core of how rate hikes influence the exchange rate lies in the ongoing changes in central bank policy expectations, which will continue to drive the volatility of major currency pairs.